We are currently witnessing a big rally in the stock market and which is possible only if there is liquidity in the market and ample amount of money available with the investors in the market. Same was the situation in 2019 =, there was a slight but very important difference to the market situation in 2019 and today in 2024 though both were similar in terms of the Stock market rally they had during this time. Let's look at the situations in 2019 and 2024 and compare them and also look at the historic data to get a judgement of what can happen in 2024.
Whenever there is a Global liquidity crisis the US FED is always at the center of this crisis as the USD is the reserve currency for all the trade that happens around the world. Whenever it prints the USD (sophisticated term : The central bank buys government bonds and other securities from the market. By doing so, it injects new bank reserves into the economy and injects it in to the system) it not just revives the US market if any liquidity crisis but also the markets around the world. In Indian context if you see the historic data the Nifty 50 has always shot up whenever US FED injected liquidity in to the system. This process of injecting liquidity into the system is also known as QE (Quantitative Easing). This also happened in 2008 global market crisis.
Opposite to this is QT (Quantitative Tightening) where the FED sucks out the liquidity from the market (sells the treasury bonds in the secondary treasury market). This is done mainly to control the inflation caused due to excessive liquidity in the market. In Indian context the nifty 50 gets volatile and cannot sustain the higher levels as it turns into a sell on rise market.
The US govt. was to have a debt ceiling deal to be presented in the Congress in a bid to lift the ceiling for its borrowing. The US govt. has a threshold for the amount of debt they can accumulate in a fiscal year. If they are short of funds and need to take debt above the threshold limit it has to present the request in the Congress (Parliament in Indian terms) where there is a tedious debate on this subject to reach a deal with consensus. This is the debt ceiling deal.
In July 2019 a deal was reached to lift the debt ceiling for 2 years. Similarly to that deals were reached in Dec 2021 and June 2023, So we can expect the new US govt will be elected by then and they can go back to the congress for another debt ceiling deal in 2025.
Whenever the debt ceiling is lifted, it basically allows the US govt. to acquire more debt. It does so by issuing US Govt. Bonds and Securities in the market with attractive long term (30yr. 10yr.) mid term (5yr. 3yr) and short term (2 yr, 6mn, 3mn) interest rates. Historically US bonds are supposed to be the safest investments on the planet, so as soon as these fresh bonds are issued the investors flock to acquire them and the money in sucked out of the global stock markets(risky investment) and diverted in the Govt. Bonds (safest investment). To get a feel of it the US govt. after the debt ceiling deal mopped up about $100bn worth of debt from the open market in the form of bonds and securities.
2019 - There was a big liquidity crisis building up to a bigger crisis in 2019, FED had to intervene and injected the much required liquidity in the market and the crisis was averted. FED printing more money and injecting that in to the system was possible as the inflation was very much under control and FED could take that step without worrying about the inflation numbers shooting out of the roof. FED was literally able to avert the crisis overnight.
After the markets recovered in 2019 after the liquidity crisis and subsequent QE by the FED, the FED started with the QT to keep the inflation in check. While the FED was cutting the liquidity from the market by the QT, the debt ceiling deal was reached and this caused a double whammy started a liquidity crisis in the markets, but before the stock markets it impacted the REPO rates (rate at which cash surplus banks lend money to cash stripped banks for short term liquidity) which started facing challenges to maintain the rates which were being offered prior to the debt ceiling deal. It reached the highest ever in history to 6.9% in Sept 2019. This was the problem caused by high demand and less supply caused due to the mop-up of liquidity by the debt ceiling and the QT by the FED, the banks were left with less liquidity available to lend. The FED had to intervene and stop the QT immediately and resume the QE process, and inject liquidity into the system, as a result the financial markets started improving and repo rate came back to a normal reasonable level.
2024 - QT started in June 2022, which was very much needed to control the spiraling inflation after 2 years of QE resulting in printing close to $5trn (helicopter money) to be injected into the system during the COVID pandemic. The QT led to start of drying up of the liquidity in the system. In March 2023, there was a regional banking crisis in the US where in 3 regional banks in US faced bankruptcies which triggered a sharp decline in the global banking stocks. FED had to intervene and inject liquidity into the banks by establishing BTFP (Bank Term Funding Program). The QT was further resumed from April after this crisis was resolved. (During this QT by early Jan 2024 the FED managed to mop-up close to $2trn out of the financial system). In June 2023 similar to 2019 the US Govt. landed in the Debt ceiling Crisis and had to reach a deal within the US congress to lift the debt ceiling and allow the Govt. to acquire more debt by issuing new Govt. bonds and securities. The fresh Treasury bills were mopping up close to $100bn per month. The QT + the fresh US treasuries were sucking out close to $200bn / month out of the system. As seen the chart below this time in 2023-2024 the impact of the debt ceiling deal + the QT was different from the impact it had in 2019 and that defied the logic. Instead of a possible market correction as a result of the liquidity crunch, the markets rallied to about 20%.
The reason behind the market rallying in 2024 even after a liquidity crunch is thought to be due to the RRP (Reverse Repo Policy). The following is the background of the RRP and why and when was it implemented.
In 2020 in the aftermath of the COVID pandemic the FED implemented QE and printed about $5trn to be infused into the market to support the businesses and individuals impacted by the pandemic. Large amounts of cash poured in to the banks in terms of deposits and as a result the interest offered by the banks collapsed to practically zero. If this continued and the interest rates offered by banks could have gone to negative which could have lead to a deflation. To come out of this situation the RRP was introduced by the FED. If you parked your money with the FED under the RRP the FED would pay a higher positive interest rate than the banks would offer. As the QE was still going on the inflation had gone out of the roof and was practically uncontrollable, as a result the FED started raising the interest rates and at a point the RRP was about 5.4% which is very high in US terms. The FED got inflows of about $2.2trn under the RRP, this can now be used to infuse liquidity in the market which had stopped due to the QT and money printing was not an option now as the inflation had spiraled out of hands. This was the reason the liquidity sucked out by QT + issuance of fresh US Govt. bonds was offset by the funds received from the RRP and there was enough liquidity available in the market which helped the markets to rally defying all kinds of logic at that time. Its self-explanatory in the charts below.
Fast forward to 2024 the FED has already used 75% of the money from the RRP funds and we still don't have a hint of rate cut, the last rate cut that happened was in May 2023 in view of the debt ceiling deal. Inflation is still not to the levels which the FED would like it to be. As of May 2, 2024, the aggregated daily amount value of the ON RRP transactions reported by the New York Fed stands at approximately $428.68 billion.
Once this cash is gone there will not be a backup account to offset the upcoming liquidity crisis as the QT will still continue and 2025 there will be a debt ceiling deal that could be sealed. Also the inflation is not helping either due to which the FED cannot cut rates left right and center.
As i had said earlier on the broadcast I expect a rate cut in mid 2024 somewhere around August / September which could be an election gimmick. Also i had talked about Japan buying US debt as an offset to China selling the US debt.
Having said all of the above since this is only the USD and the US markets, the USD is still the worlds trade currency whether we like it not. Regarding the Indian markets, the US markets would still have a greater impact on the indian markets though not as significant as earlier. The liquidity crisis spiraling can have a impact on the FII's inflows in to the Indian markets. Though the impact of FII's moving out is not as big as it was earlier still it has an impact on the indian markets.
There are three important points to study if you want to try and time the correction (which is difficult) due to the above.
1) RRP - The current rally is not a normal regular liquidity driven rally. So keep an eye on the decrease in funds under the RRP coz moment it dries out we are bound to have a crunch.
After rate cuts in the later part of 2024 the RRP funds balance is $98 billion as of Dec 2024 and depleting fast. The safety net is about to vanish and the FED cannot keep on cutting rates forever.
2) FFR - FED Funds Rate - This is the most important rate announced by the FED as it governs all types of loans e.g. the consumer loans depends on the FFR FED announces.
The FFR had peaked from Jul 06 to Jun 08 and we saw a big recession resulting in a 60% correction in the markets.
The FFR peaked again in Nov'19 resulting in another recession and correction in the range of 38% in the markets. This was also partly due to the COVID pandemic.
If we observe there is a significant lag between the point when the FFR starts to peak and the actual recession or correction taking place.
When the FFR peaks out the FED starts to cut rates as one of the counter measures to bring back liquidity in the market and increase spending power.
Fast forward 2024 the FFR is @5.33%. Economists average estimate for the Fed’s peak federal funds rate was 5.35%.
This is another reason for me saying that we could see an interest rate cut somewhere in middle of 2024 before the elections.
The FFR peaked out in September at 5.33% which led to a rate cut by the FED. The FFR is down to 4.33%. Historically when the FFR peaks out and starts to fall it is accompanied with a recession
3) Yield Curve Inversion - An inverted yield curve occurs when short-term interest rates drop below long-term rates, indicating that investors are moving money away from short-term bonds and into long-term ones. An inverted yield curve shows that long-term interest rates are less than short-term interest rates. An inverted yield curve often precedes a possible recession. The chart below shows the yield curve for 10yr bond rate - 3 mon bond rate. As of March 2024 the yield curve is deep in the negative territory. One of the measures the FED can take as a counter measure is to cut interest rates.
Another reason for me saying there could be an interest rate cut by middle of 2024.
The yield curve inversion reversal in to positive territory has just begun in December and historically this reversal is accompanied by a recession.
Reading all of the above one doesn't need to sell off the portfolio and leave the market especially long term investors should use this opportunity to buy fundamentally good stocks to add to the portfolio and follow the following points.
1) Stay Calm and Avoid Panic:
2) Understand the Context:
3) Monitor Economic Indicators:
4) Diversify Your Portfolio:
5) Government bonds: These tend to perform well during economic downturns.
6) Review Your Investment Goals:
7) Stay Informed and Seek Professional Advice:
A blog by the faceless narrator Deepak Paranjape
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