Goldman with the scenarios. Needless to say, this has in the seeds of an intensifying recession and bear market.
Two distinct regimes in the last 15 years
- In the period 2008-2016 the contemporaneous correlation between bank reserves with the Fed (liquidity) and risky asset performance was predominantly negative. The reason for that was that, since the GFC, the Fed starting adding liquidity via QE at times where the risk parity portfolio was falling in value and FCI was tightening to support FCI by lowering the term premium and long term real yield. There are estimates that the shift from low reserves to assets banking system pre 2008 to high reserves to assets one took out 140bps from the 10y term premium in U.S.
- Since the global cyclical recovery of 2016-18 which marked the start of U.S. policy normalization, the contemporaneous correlation between changes in reserves and risky asset performance has been increasingly positive as the market has “learned” the beneficial effects of higher liquidity on risk premium and tries to forecast and anticipate. The notable point in this period is the drop of reserves below 1.4tn in Sep 2019 and the resulting overnight repo rate volatility which required injection of reserves via the repo facility to stabilize the short end. At that point the Fed introduced the concept of a policy of “ample reserves” with a reserve floor currently estimated at 8.5% of nominal GDP.
