The Put Is Alive and Well
By any reasonable measure, the liquidity backdrop for risk assets looks constructive.
Treasury policy, the Fed, and liquidity conditions are all turning more supportive. It’s hard to imagine a stronger cushion for equities than that right now.
Stocks have wobbled as of late (although this week’s rampant recovery may cause recent concerns to be forgotten from memory). Some of the most prominent themes that have driven stocks higher this year, namely the ever-growing AI narrative, have faced some headwinds. However, the twin puts from the Treasury and the Fed are in play, and both monetary and market liquidity remain loose—not the usual backdrop for any bear market.
I) Treasury Secretary Yellen activated the fiscal put in 2023 to counter the Fed’s QT programme, supercharging liquidity by issuing a heavy amount of T-bills, which money-market funds eagerly bought. To pay for those bills, MMFs pulled cash from the Fed’s reverse repo facility, which then flowed into the banking system as reserves. In effect, Treasury policy pushed hundreds of billions back into the system, offsetting QT and easing financial conditions.
That allowed stocks to rally hard in 2023, emerging from their bear market.
That same put is appearing today, but from Yellen’s successor, Bessent—old wine in a new bottle. The development is fairly humorous: Bessent criticised Yellen’s approach to bill issuance and ended up adopting the same playbook. The “One Big Beautiful Bill” earlier this year was quickly followed by one big beautiful bill issuance.
But stocks don’t care. In fact, they benefit.
When net bond issuance (blue line in the chart below) climbs above 100% of the fiscal deficit, and net bill issuance (white line) is low or declining, equities tend to struggle. However, positive and rising net bill issuance has usually been a constructive signal for equities. Today fits that pattern: the one-month forward return is about average, but the three-, six-, and twelve-month readings are all stronger than their historical benchmarks.
Today’s fiscal put is a softer version of the 2023 edition, largely because the domestic RRP has already been exhausted. Still, it isn’t a liquidity headwind, which makes it broadly helpful for risk.
II) Alongside this fiscal put is Powell and his comrades. Well, maybe not Powell, but a few other members of the Fed have recently pushed a December cut back into the light with their talk. Between mid-October and mid-November, the probabilities of a quarter-point cut next month fell from 95% to 30%. Fedspeak over the last week and a half have pushed the odds back to 85%, with Fed President John Williams behind a lot of that move earlier this week.
Odds are up. Stocks are up. It’s a simple equation still driving markets.
III) Monetary liquidity rounds out the picture. No rally can claim a solid footing without it, and for now, the signals are constructive. The most important metric is excess liquidity; the gap between real money growth and real economic growth across the G10, expressed in dollars.
Think of excess liquidity as a safety net for risk assets. When it’s high and rising, that net sits closer to the market: corrections tend to be shallower, returns generally improve, and the odds of a downturn morphing into a bear market decline. When excess liquidity turns negative and continues to fall, the opposite holds. The safety net drops away, and routine selloffs are more likely to become serious.
The chart underlines the asymmetry. G10 excess liquidity is currently around +0.9, a level that has historically corresponded to roughly flat S&P 500 returns over the next six months. In other words, perfectly respectable (and once again, not the sort of backdrop that usually ushers in a bear market).
So while many fret about an AI-led selloff, the underlying liquidity conditions suggest markets are well positioned to cushion any oncoming fall. But don’t confuse that with reasons for a strong bull market to continue.
Time for my coffee,
J
