The Fed, Treasury and liquidity

A reader asked me to please explain why liquidity is rising despite the Fed hiking rates and shrinking its balance sheet (QT) by more than $1.7 trillion.

We will try to avoid the technical jargon and stick to the basics. But it’s not always an easy concept to explain or grasp.

What is liquidity?

Liquidity is not the same as money. It is more closely related to other side of the balance sheet and is best described as the “ease of financing” or availability of credit in financial markets. It includes access to credit from the domestic banking system and bond markets, as well as international financial markets.

In Reminiscences of a Stock Operator Jesse Livermore describes the operation of the Money Post on the floor of the exchange, where brokers borrowed money overnight to finance their stock operations. We have included an excerpt where he describes the impact of tight liquidity leading up to the crash of 1907. It is worth reading: The Money Tree | Jesse Livermore

How do we measure liquidity?

We use several indicators to measure liquidity in financial markets. These include:

Commercial Bank Reserves at the Fed

Commercial bank reserves spiked up in March 2023 after the Silicon Valley Bank (SVB) debacle, when the Fed introduced the Bank Term Funding Program (BTFP). Reserves continued to climb steeply until February 2024, when inflation reared its head, before falling sharply in March and April during the tax payment season.

Commercial Bank Reserves at the Fed

Chicago Fed Financial Conditions Index

The Chicago Fed Financial Conditions Index is an excellent measure of financial market liquidity, though data is normally a week behind that of bank reserves.

Chicago Fed Financial Conditions Index

Moody’s Baa Corporate Bond Spread

Moody’s Baa corporate bond spreads are a good indicator of credit availability in bond markets. The spread measures the premium that low investment grade corporate borrowers have to pay over the risk-free Treasury rate.

Moody's Baa Corporate Bond Spreads


We even use Bitcoin as the “canary in the coal mine”. Cryptocurrencies are the most liquidity-sensitive assets in financial markets and normally the first to show signs of stress.

Bitcoin climbed steeply from November ’23 until early March ’24 before stalling in March-April. Its rise in May heralded a recovery in financial market liquidity.


How the Fed and Treasury influence liquidity

The most obvious way that the Fed influences liquidity is by purchasing or selling Treasury and Agency securities in financial markets.

In April 2020, the Fed purchased almost $3 trillion in securities, expanding its balance sheet (blue below). We can also see that Treasury took advantage of these Fed purchases, issuing $1.4 trillion more in securities than it needed to fund current expenditure. The surplus shows in the TGA account at the Fed (red below) and had the effect of partially offsetting the Fed’s injection of liquidity.

Chicago Fed Financial Conditions Index

In 2021, Treasury slowed their issuance of securities, as they neared the debt ceiling, and started to draw down on their TGA account at the Fed (red above). This amplified Fed QE (blue) as it also injected liquidity into financial markets. The Fed did their best to offset this by borrowing in financial markets through overnight reverse repo operations (green above) mainly from money market funds which normally invest in T-Bills and other short-dated securities.

In late 2022, the Fed announced it was going to gradually reduce its balance sheet as securities matured. The blue area below zero is referred to as quantitative tightening, or “QT”. Since then, total assets at the Fed have shrunk by roughly $1.7 trillion. Treasury also increased net issuance and started to rebuild their TGA account balance (red) above. But the Fed was again able to offset this by lowering rates offered on reverse repo and running its RRP liabilities (green) down from almost $2.4 trillion to just $371 billion at present.

The net impact of the combined operations is shown by the blue line below. The massive combined monetary easing lasted until early 2022, when tightening commenced. But tightening ended after the March ’23 banking (SVB) crisis, with the Fed injecting liquidity to prop up financial markets until March ’24. By March, inflation was starting to rebound and the Fed may have realized that they had over-egged the pudding.

Chicago Fed Financial Conditions Index

The abrupt fall in liquidity in March-April was evident not only in bank reserves but in Bitcoin and in the stock market.


Liquidity is again rising — as shown by the the rise in Bitcoin and the fall in Chicago Fed Financial Conditions Index. Stocks and bonds are likely to rise as a result.


There are further factors that affect financial market liquidity in the US. This can include monetary easing by foreign central banks. The PBOC may inject liquidity into financial markets in Beijing or Hong Kong but the net result may ease financial conditions in New York if US T-Bills offer higher rates of return than the equivalent security in China.

We have also seen Treasury Secretary Janet Yellen change the mix of Treasury issuance in order to reduce the impact on financial market liquidity. Reducing the amount of longer maturity Treasury notes and bonds and increasing issuance of shorter-term T-Bills also helped to boost liquidity. T-Bills are the most liquid asset on the planet, with almost infinite demand. Holding a 3-month T-Bill is like holding Dollars — they have no default or rate risk — but you get a 5.0% return on top. So issuing more T-Bills has limited impact on short-term rates, while issuing less 10-year Notes , for example, will lower long-term yields when demand exceeds supply.


Tectonic shift threatening the global reserve currency system

As Mark Carney observed at Jackson Hole: the global reserve currency system is broken — it has been since Nixon defaulted on gold backing for the Dollar in 1973 — and there is no fix. We have to find a replacement along the lines of Carney’s suggestion. On Macrovoices, two experts on the EuroDollar system, Jeffrey Snider and Luke Gromen discuss the massive tectonic shift facing the global financial system.

This is a complex topic but it is important that we grasp the implications before a tsunami appears on the horizon.

Christian Noyer: Monetizing public debt

Christian Noyer, Governor of the Bank of France and Chairman of the Board of Directors of the BIS: Some central banks have developed large-scale public debt acquisition programmes. They have done so for reasons relating to immediate macroeconomic stabilisation… to go beyond the zero-interest rate limit. The Eurosystem as well intervened on a much smaller scale when malfunctioning debt markets prevented the effective transmission of monetary policy impulses. There is not a single central bank that is seriously considering the monetisation of deficits with the more or less declared intention of reducing the weight of debt via inflation. In my view, this notion is nothing more than a financial analyst’s fantasy.

via Christian Noyer: Public and private debt – imbalances of global savings.
Comment:~ No central bank has declared an intention to monetize public debt (or deficits) — reducing public debt via inflation — but without a viable alternative how many will end up there? Gary Shilling points out that “competitive quantitative easing by central banks is now the order of the day.” The Bank of Japan last year “expanded its balance sheet by 11 percent, while the Federal Reserve’s increased 19 percent, the European Central Bank’s rose 36 percent and the Swiss National Bank’s grew 33 percent.” Japan, after 20 years of stagnation and with net public debt at 113% of GDP, illustrates the predicament facing many developed countries. If there was a plan B they would have tried it by now.

Christian Noyer: Public and private debt – imbalances of global savings

Christian Noyer, Governor of the Bank of France and Chairman of the Board of Directors of the BIS: My first remark….. In advanced countries, the average public debt to GNP ratio is 100%. In emerging countries, the figure is 30%. This is a very wide gap, and it represents one of the global economy’s largest imbalances. And one of the least mentioned. It also represents a complete reversal of the situation compared with just over twenty years ago…..
Second remark, global demand is still fairly concentrated on the advanced countries. Not only is their debt higher, but their savings (as a ratio of GNP) are lower. The G7 countries alone still account for 56% of global consumption. The problem is clear. How can we hope to raise our level of consumption if we need to reduce our level of debt and increase our savings? And if the advanced countries’ consumption stops growing, what will happen to global economic growth and particularly that of emerging countries with entirely export-oriented economies?

via Christian Noyer: Public and private debt – imbalances of global savings.