Lykeion Research - September '23

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Bond Issuance’s Impact on Liquidity

So what: The Fed will be adding duration to Treasuries issued over the next 9 to 12 months, which will effectively remove liquidity from equity markets at a time when they’ll likely be facing recessionary headwinds.

Deficit financing used to be relatively easy:

1)     Foreign buyers buy a chunk of treasuries

2)     Banks and investors take another chunk

3)     Use the Fed as buyer of last resort to take the rest

 That’s no longer the case: Geopolitical tensions have slowed (1) meaningfully; (2) is still an option, but the costs are rising; J. Powell’s crusade against inflation has mostly put an end to (3) via QT.

But the US Government still needs to finance its fiscal deficit and given the setup - significantly higher rates and historically large deficits - the Treasury will likely be forced to remove a significant amount of liquidity from the market over the next 9-12 months, which could very well be the long-awaited catalyst that the bears like Michael Burry and Mike Wilson have been looking for.

Let us explain. What’s the impact of Treasury issuance on liquidity?