April seventh, two thousand twenty-five

I. Foundation 

resistance to change and hence greater dependability for the results shown in the past.

Global Liquidity (One): Interest Rates Are Not the Main Story; Liquidity Is Key

It’s not about interest rates. It’s about balance sheet...

With tariffs taking effect, everyone’s attention is turning to the Federal Reserve, The market’s real focus is not a topic like “how many rate cuts,” but whether the liquidity and reserve structure of the entire system remains in an ample regime and whether it is approaching the edge of a scarce regime.

The liquidity classification commonly used by the Federal Reserve and markets is: ample / abundant / scarce

In fact, since the pandemic, the global liquidity system has remained in a highly ample reserve regime over the past few years. Looking further back, our starting point today follows at least a decade of abundant liquidity and a compressed Debt-to-Liquidity ratio. The main reasons for this situation are:After the global financial crisis of 2008, central banks injected liquidity on a large scale to stabilize the financial system; then, during the pandemic, they implemented unprecedented monetary easing on top of that.

These actions created an extremely loose liquidity environment and also lowered the traditional “debt/GDP” ratio. In addition, the prolonged zero-interest-rate environment encouraged many companies and governments to “extend the duration” of short-term debt in what is known as “debt maturity transformation.”

But by the second half of 2024, this pattern was on the verge of reversing, and systemic reserves were rapidly sliding toward a “scarce regime.”Previously, markets borrowed at extremely low interest rates and postponed repayment schedules. But these debts with extended maturities are gradually coming due, and the so-called “debt maturity wall” will be a major challenge for capital markets over the next two to three years.

— A large volume of medium- and long-term debt that was previously “locked in” is heading toward concentrated maturities.

By definition, this reversal in the liquidity–debt relationship is enough to end the current bull market. Although it may not be enough to directly trigger a systemic bear market, its destructive force cannot be ignored.

Further reading: Notes 250407 Powell and Yellen’s trick: “Pump and Dump”

If you extrapolate what’s happening at the Fed, the money probably runs out this September. It’s not a question of probability; it’s a question of the path.

The essential definition of liquidity can be put in one sentence: at its core, it is the financial system’s balance sheet capacity.

This definition is rough and broad, but it is the most basic starting point.

The current system needs more liquidity, which essentially means an expansion of balance sheets.

This is why liquidity is crucial—we live in a “debt-driven” economic system. Debt dominates everything. Vast amounts of outstanding debt must be refinanced every year. Today’s capital markets are no longer primarily about raising funds for new investment projects; they revolve entirely around “debt rollover.”

Debt rollover requires sufficient balance sheet capacity within the system. This capacity depends on the extent to which the entire financial system expands. But the expansion of the financial system itself is constrained or guided by policy boundaries imposed by central banks and regulators.

If the central bank itself is shrinking its balance sheet, it is difficult for the financial system to expand its balance sheet in parallel. In that situation, the Federal Reserve must step back in and expand its own balance sheet.

Further reading: Notes 250402 Positioning America (Five), Path Dependence: QE Is Not QE, and Liquidity Injections Are Not Liquidity Injections

Most large transactions in the market are essentially debt rollovers rather than new capital raising. If debt cannot be rolled over smoothly, the market structure will break down. When it can no longer be rolled, it is not a matter of price but of survival. The core issue, therefore, is not the level of interest rates, but whether there is room on the balance sheet to absorb it.

If liquidity is insufficient to support the debt structure, systemic risk can be triggered even without a rate hike. The Federal Reserve’s continued QT will bring “liquidity compression,” effectively removing the financial system’s capacity to refinance.

Liquidity is currently somewhere between abundant and ample, but “very close to the edge.” If we linearly extrapolate variables such as the current QT pace, RRP depletion, and TGA rebuild, reserves will fall below the system’s critical threshold by this 9 at the latest, and we will then reenter a period of mismatch similar to the repo crisis of 2019 9.

The repo market is already pricing in this situation. In the repurchase market, spreads are continuously widening, which is a very clear trend.This persistent widening of spreads has surely alerted Federal Reserve policymakers. They have said they do not want to repeat the repo market crisis of 2019, but we are indeed moving step by step toward that edge.

The spread between SOFR and Fed Funds continues to widen. Spread widening is the most typical early warning signal, and this trend is almost a shadow of the eve of 2019 9. Uneven reserve distribution within the system, diverging reserve structures at large and regional banks, rapid depletion of RRP balances, and continued QT together form a typical liquidity exhaustion path.

The core of modern liquidity is not a standalone, static concept, but a dynamic intersection of liquidity × collateral × balance sheet capacity.Paying attention to liquidity means keeping a close eye on collateral, and the repo market is precisely where these two key variables—liquidity and collateral—intersect, Repo rates will be a very important indicator this year.

If collateral quality deteriorates and balance sheet capacity is constrained, liquidity in the system could suddenly freeze even if the quantity of reserves has not changed. To understand the current financial system, we cannot look only at interest rates; we must examine repo collateral structure, reserve tiers, and balance sheet availability across the entire system.

The banking system’s balance sheet capacity is shrinking, and regulators are continuing to strengthen reserve buffer requirements for banks. This This structural squeeze can be resolved only through active balance sheet expansion by the Fed or a blowup in shadow credit; there is no neutral option in between.

Further reading: Notes 250331 Positioning America (Three): The Fragile Symbiosis Between Private Credit and Pensions

Further reading: Notes 250402 A Non-Bailout Version of QE: Operation Twist 2.0

We have entered a debt-refinancing-driven world in which the balance sheet itself is the core variable. Today’s markets are no longer the capital-expenditure-driven world where interest rates determine investment returns—the defining variable of this era is no longer the level of interest rates, but balance sheet capacity..

This is a paradigm shift in the macroeconomic narrative.

2025.04.07

Powell and Yellen’s Trick: “Pump and Dump”

The essence of Pump and Dump is to inject a whole package of hidden stimulus policies into the U.S. economy through a series of rule-bending actions.Specifically, these were a series of actions taken by Powell and Yellen in 2024, which, from one perspective, were intended to help Biden secure reelection... Although the outcome was clearly unsuccessful... a package of “hidden stimulus policies” was nonetheless injected into the U.S. economy.

This hidden stimulus policy could be called “QE, not QE”—that is, a series of actions by the Federal Reserve outside its official QT or balance sheet policy.

“Balance sheet policy” mainly refers to FOMC’s current definition of QT: allowing U.S. Treasury securities to mature without reinvesting, thereby shrinking the balance sheet. Conversely, if they continue buying Treasuries, that falls under QE operations.

And this has in fact moved away from the original conception of QE. Returning to the Bernanke era, he emphasized that the essence of QE is transmitted through changes in bank reserves (he stated this very clearly); today, the Federal Reserve’s definitions of QE and QT have increasingly been stretched to fit.

Further reading: Notes 250328 Four Different Forms of QE: Introducing the Concept of Monetary Financing

Further reading: Notes 250328 Recalibrating the Definitions of QE and QT

“QE, not QE” refers to Federal Reserve operations outside Treasuries and MBS, including RRP (the reverse repo facility), the reduction in RRP balances, fluctuations in the Treasury General Account (TGA), operating losses on the Fed’s holdings, and the now-discontinued BTFP (Bank Term Funding Program)—In essence, it is liquidity injected into the system by the Federal Reserve outside its official QT policy. In other words, they are not truly tightening but are secretly carrying out “hidden QE”—hence the phrase “QE, not QE.”

Under Janet Yellen’s leadership, the U.S. Treasury very cleverly chose to finance the government through short-term Treasury securities (bills).Since the end of 2023, more than 60% of U.S. deficit financing has been carried out in the form of Treasury bills, an astonishingly high proportion by modern historical standards.

Treasury bills are very short-term government bonds, typically maturing within 12 months and paying no interest (that is, zero-coupon bonds). These instruments are popular with banks and credit institutions. But When these financial institutions buy large amounts of bills, it is effectively a direct “monetization of the fiscal deficit.” If we consider the liquidity generated by the Treasury’s changes to its funding structure and increased short-term borrowing together with the Federal Reserve’s “Not-QE QE” operations, we can see a real process of systemic liquidity injection.

In essence, fiscal and monetary policy jointly implement a form of “duration management.”

This is actually another disguised form of YCC operations.At the beginning of 2024, this type of liquidity injection reached a peak of about 6 trillion dollars in total, effectively giving the market and the real economy a shot in the arm. This is very real additional liquidity that continues to flow into the system.

Further reading: Notes 250402 A Non-Bailout Version of QE: Operation Twist 2.0

Throughout 2024, it was clear that this liquidity stimulus was rapidly winding down, with the remaining stimulus already below 1 trillion dollars. What really matters is the “second derivative”—that is, the rate of marginal change. Understanding this marginal liquidity contraction is central to judging market and economic trends: marginal liquidity is highly correlated with the Philadelphia Fed Manufacturing Index, with a lag of about 9 months.

The global economic slowdown caused by this fading liquidity had already become clearly apparent since mid-12 last year, and it began before tariffs became the market’s focus. This shows that the global economy had already been slowing quietly and was not directly driven by recent trade tensions.

A major factor behind this slowdown is the ebbing of this “hidden stimulus.” This is why evidence of economic deceleration is now gradually emerging. The increase in tariff uncertainty is merely a macroeconomic trigger that intensifies this trend.

2025.04.07

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