Liquidity Has Fallen Off A Cliff | Joseph Wang & Michael Howell

Episode Summary

Executive Summary: Joseph Wang and Michael Howell argue that global liquidity—not just interest rates—is the dominant driver of markets. They see a rapid liquidity contraction from central bank QT, higher rates, and funding shifts into reverse repos, with more pain ahead for stocks, crypto, and credit before a potential rebound once the Fed pivots back to easing.

Main Topics: Defining liquidity: quantity, funding, and market depth (Priority: 5/5): Both guests stress that liquidity is more than money supply. It includes funding capacity, market depth, balance-sheet availability, reserves, deposits, money market funds, and cross-border flows, all of which affect asset pricing. Liquidity contraction and risk-asset declines (Priority: 5/5): Howell argues the collapse in his global liquidity index is driving the sell-off across equities, crypto, fixed income, and eventually housing and credit; Wang agrees the market still has more downside. QT versus rate hikes (Priority: 5/5): The discussion centers on whether quantity policy (QT/QE, balance-sheet changes) matters as much as price policy (Fed funds). Both say QT and funding conditions can matter as much as, or more than, rate hikes. Fed balance sheet, RRP, and hidden tightening (Priority: 5/5): They explain how reverse repos, Treasury General Account flows, and shrinking Fed holdings can drain liquidity even before the official balance sheet fully rolls off, creating a de facto tightening cycle. Inflation, recession, and the Fed’s tolerance for pain (Priority: 4/5): They expect the Fed to prioritize inflation reduction over asset prices, even if that means a recession and lower equities, with a possible pivot only after economic stress becomes severe. Treasuries, term premium, and the bond market setup (Priority: 4/5): Wang and Howell disagree mildly on timing but agree the front end reflects hikes while the long end depends on term premium, term structure, and future recession dynamics; both see volatility ahead. Geopolitics, the dollar system, and China (Priority: 4/5): Howell frames liquidity through a geopolitical lens: the dollar-centric system, friend-shoring, pressure on the yuan, China’s need for a stable currency, and the possibility of a fragmented global financial order.

Key Arguments: Global liquidity, not just rates, is the key macro variable driving risk assets; market outcomes track funding conditions closely. A 55% drop in Howell’s global liquidity index since 2020 aligns with major declines in stocks, crypto, fixed income, and IPO activity. QT drains capacity from the system and can tighten conditions as much as or more than rate hikes because refinancing, not new borrowing, dominates modern finance. The Fed’s lender-of-last-resort role has expanded from banks to dealers, money funds, corporates, and even aspects of the real economy, making it more powerful than in 2008. Reverse repo usage can absorb enormous amounts of cash and act like “hidden QT,” potentially pushing deposits and M2 lower. The Fed is likely willing to accept substantial equity declines if markets remain orderly and the plumbing of the financial system continues to function. Long-duration Treasuries may become attractive later, but supply, term-premium dynamics, and global bond-market shocks argue against rushing in now. China’s policy priority is currency stability and strategic positioning versus the dollar, even at the cost of weaker domestic growth. A recession appears likely in the U.S. after Asia and Europe, and inflation persistence resembles the late 1970s more than a temporary spike. The likely market pattern is continued pain now, followed by a sharper rebound only after the Fed reverses course and reintroduces QE.

Data Points: Global liquidity index peak: Just under 90 in 2020-2021 - Howell says his global liquidity index reached a 50-year high during the pandemic era. Global liquidity index recent reading: About 40 - He says the index fell from the high 80s to roughly 40, a multi-year low. Global liquidity decline: About 55% - Howell estimates the drop from peak to current levels. SPX futures market depth decline: 67% - He cites a Goldman estimate of reduced depth in S&P 500 futures as evidence of liquidity stress. Global debt stock: $300 trillion - Howell uses this to explain the refinancing burden on the financial system. Annual debt rollover need: $60 trillion per year - Based on a roughly five-year average maturity of global debt. Global capex spending: About $20 trillion - Howell estimates global capital expenditure as roughly 20% of $100 trillion GDP. Fed SOMA path: From over $8 trillion to under $6 trillion - Howell references New York Fed projections for the System Open Market Account over several years. Fed balance sheet later path: Back toward about $7 trillion by 2030 - Howell says projections imply the Fed may expand again after the planned shrinkage. RRP potential: Could reach $3 trillion by year-end - Wang says money funds may pour into the Fed’s reverse repo facility. US bank reserves decline: Down about $1 trillion since end of last year - Howell cites reserves as evidence of tightening even before official QT fully ramps. Treasury supply/QT burden: About $1.5 trillion per year - Wang says this is the amount the market may need to absorb in coming years. Bank credit growth: No precise number; described as very strong - Wang says credit creation remains robust for now despite slowing growth risks. Inflation persistence: About 0.8 next month and 0.6 the month after - Howell says U.S. inflation shows late-1970s-like persistence. Terminal Fed funds implied by markets: Around 3.6% - Howell cites the forward curve. Estimated Fed funds ceiling: Around 3.0% to 3.5% - Both speakers suggest the economy may struggle above this range. Fed QT pace: About $1 trillion per year - Wang says the Fed’s plan implies shrinking the balance sheet by roughly a trillion annually. Potential short-term equity levels: S&P 500 around 3,200 or 2,500 in downside scenarios - Howell eyeballs liquidity-to-market relationships under different QT/RRP assumptions. Yen depreciation: Annualized 83% over 40 trading days - Howell uses the yen’s move as evidence of unusual geopolitical or policy pressure. China reserve drain: 800 billion yuan (about $120 billion) - Howell says the PBoC took liquidity out of the system in April and May. Yield curve reference: 10s-5s spread used as a proxy for term premium - Wang explains how the curve helps separate rate expectations from term premium.

Pivotal Quotes: "“Liquidity is something different for us, it’s effectively a measure of the financing capacity of the financial sector, the ability to fund positions.”" — Michael Howell: Howell’s core definition of liquidity and why it matters for markets. "“It’s not about the cost of capital, it’s about the capacity of capital.”" — Michael Howell: Explaining why balance-sheet constraints and QT matter as much as rate hikes. "“The best scenario for risk assets nine months out is for us to crash right now, so we restart up the QE cycle.”" — Joseph Wang: Wang’s blunt view on the path to a future market rebound.

Implications: Expect continued volatility and downside pressure in risk assets as liquidity drains and the Fed stays restrictive. Investors may eventually find opportunity in long-duration Treasuries, gold, crypto, and quality risk assets only after a policy pivot.