The Stealth Liquidity Squeeze

U.S. Treasury officials have reluctantly deployed covert tightening

After easing financial conditions via a series of covert actions, monetary leaders can no longer pretend to tighten. The dark side of Quantitative Tightening (QT) has been unleashed, not by the Fed itself, but by the U.S. Treasury. The Stealth Liquidity Squeeze™ is here.

In early winter at the start of 2022, the Federal Reserve announced it was undertaking the monumental task of unwinding its $9 trillion balance sheet. The U.S. central bank’s second Quantitative Tightening (QT) program had officially commenced. This coincided with the Fed’s full-blown tightening cycle, including sharp rate hikes that shook markets globally. Anticipating peak liquidity and growth, plus the death of the “inflation is transitory” narrative, risk assets — once powered by a huge speculative frenzy — sold off sharply. Subsequently, the idea that QT was a major drag on asset prices had been cemented.

As months and quarters passed, however, QT took a backseat. Slowing growth and intense rate hikes were blamed as the primary causes behind the popping of the greatest market mania on record. The Federal Reserve’s “inflation rug pull” had resulted in a slow, protracted 45% decline in equities, a once-in-a-lifetime selloff in government bonds, and the collapse of many crypto empires. Despite the decline, the stability of the system persisted, but only until September 2022.

The near-failure of U.K’s bond market and the following intervention by the Bank of England marked the bottom for global liquidity. Still, whether intentional or not, monetary authorities globally, but especially the Fed and U.S. Treasury, maintained a tightening stance publicly. Yet behind the scenes, they continued to supply enough liquidity to stave off any crisis. After multiple episodes, from a banking panic to a debt ceiling fiasco, they unofficially gave up on enforcing any meaningful tightening. “Stealth QE” was the new policy.

As 2023 arrived, the debt ceiling quarrel forced the U.S. Treasury to draw down almost its entire bank balance in the TGA (Treasury General Account), pushing reserves back into the system, thus once again offsetting QT’s ability to hinder liquidity. What’s more, the U.S. Treasury continued to issue only short-term government debt, further hindering QT’s impact to quash risk sentiment. Even after the Silicon Valley Bank collapse emerged, the U.S. government’s bailout of depositors and regional bank rescue programs only further reinforced the idea that monetary leaders were willing to do anything to ease financial conditions, still without an official pivot. By implementing the BTFP (Bank Term Funding Program), the Fed signaled to the market that they were willing to remove as much interest rate risk as needed. Bond volatility decreased rapidly, which rippled into credit and other risk assets, juicing markets further. With liquidity sustained, the U.S. economy grew more resilient than most economists had expected.

Fast forward to today, liquidity has remained so abundant that even the resolution of the debt ceiling and the ensuing “TGA refill” have failed to subdue risk asset prices. But the tide is now turning. After a series of false alarms, the Fed’s QT has begun to dampen risk appetite. With Janet Yellen issuing a sea of riskier bonds into the market, it’s the U.S. Treasury’s latest actions, not the Fed’s, that have begun to impair risk assets. TQT (Tighter Quantitative Tightening) has been activated, unleashing a stealth tightening effect on markets that most liquidity indicators won’t detect. What does that mean in practice? It’s time to go deeper into the mechanics.