Matt King at Citi is always worth a read:
…we reckon many risk assets are in a bubble which has been growing since 2013.
This has necessitated one of several shifts in the way we do strategy, and feels like one way in which this time really is different. Traditionally we would spend a lot of time trying to work out how bullish or bearish the consensus of active investors is, and then position against it. But in this bull market, active investors have seldom felt particularly exuberant. Even when they have shown modest signs of being overly long, more often than not, especially in credit, these excesses have been resolved through end-investor inflows – driven by the broader backdrop of money creation and reach-for-yield – reducing active longs vs benchmarks, rather than through actual selling. Conversely, sell-offs have been triggered not necessarily by active investors becoming more bearish but almost always by outflows (Figure 4).
…For many years we have tended to judge central bank liquidity metrics on the basis of the strength of their relationship with market movements. The “right” metric to track has been that with the best explanatory power. On this basis we have tended to argue that global metrics beat local ones, that it is easier to see relationships with credit and equities than with govies, that flows or impulses are more important than levels or announcements, that cash volumes are more significant than potential duration or asset class effects, and that outright purchases through QE are much more powerful than even long-dated repos.
However, an alternative metric suggests a radically different outlook. A few months ago we shifted to using a metric for the Fed which looks at changes in bank reserves rather than simple securities purchases, largely so as to adjust for the effect of changes in the Treasury General Account (Figure 12).
There is a theoretical argument – which seems plausible to us – that increases in the TGA act almost as negative QE. When the Treasury issues bills or bonds, someone in the private sector needs to buy them. If the Treasury then spends that money in the real economy, this makes little difference – it is still there to circulate.
But if they simply deposit it at the Fed, liquidity has effectively been absorbed from the private sector and sits idly on the Fed’s balance sheet.
…The US Treasury recently confirmed that it expects much of this increase to be reversed in coming months, thereby releasing liquidity back into private investors’ hands…a $1-1.5tn reduction by around July still seems very likely, especially in the event that a further stimulus bill is passed, followed by a modest rebuild thereafter. The critical question is whether this is indeed the “right” metric to be tracking for markets. If it is, then for several months the stimulative effect of $120bn in monthly Fed purchases looks likely to be more than tripled.