TLDR

While Powell’s Dovish Federal Reserve (the Fed) has reduced its balance sheet by $256 billion in the past three months, net liquidity has only decreased by $80 billion.

Wait, what? This is due to TIFFIT, or Treasury is Fed, Fed is Treasury.

You can read about TIFFIT in my five-part series here, but in a nutshell, while the Fed appears to be withdrawing liquidity by reducing its balance sheet, the Treasury is injecting money back into the markets. Essentially, they’re working together.

And in a backdrop of smaller-than-expected liquidity reduction, Australia is set to get its first spot Bitcoin (BTC) ETF. Given BTC and crypto are highly correlated to liquidity, and considering the tougher economic conditions facing Aussie householders, the performance of this ETF in front of a backdrop of declining liquidity and higher interest rates, will be interesting to watch.

TIFFIT revisited

Under TIFFIT, while the Fed reduces liquidity through balance sheet reductions, the Treasury adds money back into the economy. This is done through:

• The Treasury General Account (TGA): When it pays government bills.

• The Banking System: By running down the reverse repo account (RRP), which slows the reduction of bank reserves, leaving more liquidity in the system.

When these factors are considered, the net liquidity reduction over the past quarter was only $80 billion, not $256 billion.

Smoke and mirrors.

Liquidity reduction of $80 billion is certainly not the Death Star, but it explains the sideways chop

The overall $80 billion decrease in liquidity (the main driver of asset prices) partially explains why the bull market in equities has continued, albeit sideways for some assets, with the rest explained by future expectations of AI monetisation and digital GDP.

Markets have been anticipating higher liquidity and potential interest rate cuts from the Fed. However, due to persistent inflation, these cuts have not materialised (as I have been warning for many months). This has contributed to the current market "sideways chop" for most stocks, other than for the all-time highs we continue to see for stocks like NVDA and other apparent AI beneficiaries like Microsoft and (recently) Apple, etc.

With the upcoming U.S. election, more Treasury spending is expected, but until then we can expect more of the same market behaviour - which is to say sideways chop for most stocks, and super high returns concentrated in a few big names.

The situation in Australia

In Australia, the Reserve Bank (RBA) is tackling stubborn inflation while trying to maintain low unemployment and avoid recession. Despite higher rates, Australia's debt-to-GDP ratio remains low.

Risk assets in Australia have stagnated since their post-COVID peak in August 2021, with the S&P200 showing minimal growth of 2.6% since August 2021. We all know the ASX isn’t known for exponential growth companies, and with higher rates and inflation, even major miners and industrials are struggling.

So, with U.S. liquidity yet to hit international markets, RBA in a bind, ASX quoted equities trading sideways, and the 30 June loss-taking window already started, it may not be such a buoyant market on ASX until the second half of this year, or perhaps 2025.

Spot bitcoin (BTC) ETF on ASX to show the way?

As I’m sure you’re aware, crypto is highly correlated to liquidity, and price action in crypto leads price action in equities by a few months.

Therefore, the launch of Van Eck’s spot BTC ETF, which is scheduled to hit ASX on Thursday, should provide a decent indication of market sentiment in this reduced liquidity environment.

And considering the economic challenges we have here at present, and that institutional investors have had access to the U.S. spot trusts for some time now, we might see a very different reception to this ETF than the extremely positive U.S. experience of a few months ago.

See you in the market.

Mike