From April seventh, two thousand twenty-five to April tenth, 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 is turning their attention to the Federal Reserve, The real market 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 classifications commonly used by the Federal Reserve and the market are: ample / abundant / scarce

In fact, since the pandemic, the global liquidity system has been in a highly ample reserve regime for the past few years. Going further back, our current starting point is a period of at least ten years of abundant liquidity and a lower Debt-to-Liquidity ratio. The main reason for this situation is:After the global financial crisis of 2008, central banks injected liquidity on a massive scale to stabilize the financial system; then, during the pandemic, they implemented unprecedented monetary easing.

This round of measures created an extremely loose liquidity environment and 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 through so-called “debt maturity transformation.”

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

—A large volume of previously “locked-in” medium- and long-term debt is tending to mature all at once.

By definition, this reversal in the liquidity-debt relationship is enough to end the current bull market. Although it may not yet be enough to directly trigger a systemic bear market, its destructive force can no longer be ignored.

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

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

The essential definition of liquidity can be summed up in one sentence: its core is the balance-sheet capacity of the financial system.

Although this definition is rough and broad, it is the most fundamental starting point.

The system currently needs more liquidity, which essentially means expanding balance sheets.

This is why liquidity is crucial—we are in a debt-driven economic system. Debt dominates everything. Every year, enormous amounts of outstanding debt need to be refinanced. Today's capital markets are no longer centered on “raising funds for new investment projects”; they revolve entirely around “debt rollover.”

Debt rollover requires sufficient balance-sheet capacity in the system. That capacity depends on how much the financial system as a whole expands. But the expansion of the financial system itself is constrained or guided by the policy boundaries imposed by central banks and regulators.

If the central bank itself is shrinking its balance sheet, it is very difficult for the financial system to expand its balance sheet at the same time. In that situation, the Fed must step back in and expand its own balance sheet.

Further reading: Notes250402 Locating America (Five), Path Dependence: QE is not called QE, and liquidity provision is not called liquidity provision

Most large transactions in the market are essentially debt rollovers rather than new capital raisings. If debt cannot be rolled over smoothly, the market structure will fracture; when rollover stalls, it is not a matter of price but of survival. Therefore, the core issue is not the level of interest rates, but whether balance sheets have room to absorb the debt.

If liquidity is insufficient to support the debt structure, systemic risk can be triggered even without rate hikes. The Fed continuing QT will bring “liquidity compression,” equivalent to pulling the financial system’s refinancing capacity away.

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

The repo market is already pricing in this situation. In the repo market, spreads are widening continuously; this is a very clear trend.This persistent widening of spreads has certainly put Fed policymakers on alert. They said they did not want a repeat of the 2019 repo market crisis, but we are indeed moving closer to that precipice step by step.

The spread between SOFR and Fed Funds is widening steadily. 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 classic liquidity exhaustion path.

The core of modern liquidity is not a standalone, static concept, but a dynamic intersection of liquidity × collateral × balance-sheet capacity.Focusing on liquidity means paying close attention to collateral, and the repo market is precisely where these two core 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, the system could suddenly freeze up for lack of liquidity, 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 structures, reserve tiers, and balance-sheet availability across the entire system..

The banking system’s balance-sheet capacity is shrinking, and regulators are still tightening reserve-buffer requirements for banks. This kind of structural squeeze can only be resolved through active balance-sheet expansion by the Fed or a shadow-credit blowup. There is no neutral option in between.

Further reading: Notes250331 Locating America (Three): The Fragile Symbiosis of Private Credit and Pensions

Further reading: Notes250402 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 market is no longer the world driven by capital expenditure, 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 into the U.S. economy through a series of operations outside the rules.Specifically, these were a series of actions taken by Powell and Yellen during 2024, which, from one perspective, were intended to build momentum for Biden’s reelection... Although the outcome clearly was not successful... an “invisible stimulus package” was indeed injected into the U.S. economy.

This package of hidden stimulus policies can be called “Not-QE QE,” meaning that this part consists of a series of operations the Federal Reserve carries out outside its official QT or balance-sheet policy.

“Balance-sheet policy” mainly refers to QT under the current FOMC definition: letting U.S. Treasuries mature without reinvesting the proceeds, thereby shrinking the balance sheet. Conversely, if they continue buying Treasuries, that falls under QE operations.

This has already diverged from the original conception of QE. Going back to the Bernanke era, he emphasized that the essence of QE is transmitted through changes in bank reserves (he stated this very explicitly). Now, the Fed is increasingly stretching the definitions of QE and QT.

Further reading: Notes250328 Four Different Forms of QE: Introducing the Concept of Monetary Financing

Further reading: Notes250328 Recalibrating the Definitions of QE and QT

“QE that is not QE” refers to operations by the Fed outside Treasuries and MBS, including RRP (the reverse repo facility), the reduction in RRP balances, fluctuations in the Treasury General Account (TGA), operating losses generated by the Fed’s assets, and the now-discontinued BTFP (Bank Term Funding Program), among others—In essence, the Fed injects liquidity into the system outside its official QT policy. In other words, it is not really tightening; it is quietly conducting “hidden QE.” That is where the expression “QE that is not QE” comes from.

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

Treasury bills are very short-term government securities, 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 quantities of bills, it is effectively the direct “monetization of the fiscal deficit.” If we consider the liquidity generated by the Treasury’s adjustment of its financing mix and increased short-term borrowing together with the Fed’s “Not-QE QE” operations, we can see a genuine process of systemic liquidity injection.

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

This is actually another way of conducting YCC operations in disguise.At the beginning of 2024, total liquidity injections of this kind peaked at about 6 trillion dollars, essentially giving the market and the real economy a shot in the arm. This was a very real additional source of liquidity flowing continuously into the system.

Further reading: Notes250402 A non-bailout version of QE: Operation Twist 2.0

But throughout 2024, we can see this liquidity stimulus winding down rapidly, with the remaining stimulus now below 1 trillion dollars. What really matters is the “second derivative”—that is, the rate of change at the margin. Understanding this marginal liquidity contraction is central to assessing the market and economic outlook: marginal liquidity is highly correlated with the Philadelphia Fed Manufacturing Index for U.S. equities, 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 we are now seeing evidence of economic deceleration gradually emerge. The rise in tariff uncertainty is merely the macroeconomic trigger that intensifies this trend.

2025.04.07

U.S. Treasuries/Gold: A Geopolitical Relative-Valuation Framework

For sovereign reserve managers, the dollar has no genuine substitute within the existing fiat-currency system. Gold may be the only asset without counterparty risk, the problem being that it is difficult to transport and trade, yields no income, and carries a holding cost (the dollar funding rate + storage costs − convenience yield). By contrast, current U.S. Treasuries can provide an interest return of 4%-5%.

Historically, whenever concerns about U.S. fiscal excess or geopolitical risk intensify, U.S. Treasuries tend to depreciate relative to gold.

The early 2000s are a good example of U.S. Treasuries depreciating relative to gold:

because the United States had to fight a recession and increase military spending after 9 11. Geopolitical relations were highly tense during the “War on Terror.”

2008-2015, after the global financial crisis, U.S. Treasuries appreciated relative to gold:

The main reasons were 1) the U.S. deficit was not a major problem, because the current account and budget balance did deteriorate sharply, but this was temporary and recovered in 2013; 2) the Fed supported the value of U.S. Treasuries through QE; 3) geopolitical relations were broadly stable, and most governments were focused on dealing with the effects of the global financial crisis.

The pandemic period of 2020:

The U.S. twin deficits surged, but U.S. Treasuries remained stable relative to gold because 1) the rest of the world and the United States were “in the same boat,” with a synchronized global recession, while the United States was “the cleanest shirt in the dirty laundry”—relatively speaking, the most stable region; 2) governments were busy handling domestic problems caused by the pandemic and dealing with their own domestic-demand difficulties.

Since 2022:

Since the Russia-Ukraine war and the subsequent financial sanctions took effect, U.S. Treasuries have gradually depreciated relative to gold.

Finally, the most important chart for examining the relationship between U.S. Treasuries and gold:

White line = U.S. twin deficits (current account + budget balance, as a percentage of GDP, left axis)

Yellow line = total outstanding U.S. Treasury debt divided by the price of gold

Red shaded areas = U.S. recession periods

2025.04.08

Global Liquidity (Two): A Collateral-Driven Liquidity System & Two Control Mechanisms

Activity in the dollar system is shifting from traditional banks to shadow banks, driven by regulatory arbitrage. This structural shift is largely due to a regulatory metric such as SLR (Supplementary Leverage Ratio), which allows shadow banks to bypass capital constraints and expand rapidly.

Regulations have essentially made it very difficult, or even unprofitable, for banks to conduct business through their own balance sheets. As a result, a great deal of activity has shifted to other nonbank credit providers or has simply been “moved off balance sheet” into off-balance-sheet business.

This means that the current financial system has two control mechanisms, which is key to understanding how the entire liquidity system works.

The first is the lender-of-last-resort function, a core responsibility of traditional central banks: maintaining system stability by providing reserves to commercial banks. This function operates through the traditional banking channel, which has traditionally centered on “safe-asset investment” and therefore serves to dampen volatility—that is, it has a countercyclical character.

The other control mechanism revolves around the shadow-banking system and represents an “emerging function”: the central bank (or the central bank plus the Treasury)tries in this mechanism to play the role of dealer of last resort, with the core objective of stabilizing or supporting the market value of collateral.

The importance of collateral pricing is self-evident: it directly determines the system’s capacity to generate systemic liquidity.

And that is also where the problem with a collateral-driven liquidity system lies: the more the system shifts toward the shadow-banking side and relies on private debt assets as collateral, the farther those assets move beyond the reach of the “official safety net”, and the risks become increasingly difficult to control. Ultimately, these mechanisms amplify deviations and reinforce procyclicality (deviation amplifying, pro-cyclical)—and this is the source of a potential crisis: what is the “integrity” of private-sector collateral? It is not fully backstopped by central banks or fiscal authorities; that is the greatest systemic vulnerability.What is the “integrity” of private-sector collateral? It is not fully backstopped by central banks or fiscal authorities, and that is the greatest systemic vulnerability.

Once the macroeconomy begins to slow, this structure can easily trigger a negative feedback loop and ultimately cause a financial-chain breakdown resembling a “cascade down”—as seen in 08.

In the first series, we provided a good indicator for monitoring this risk:

The spread between the SOFR rate (the current benchmark rate in the repo market) and the federal funds target rate.

Related reading: Notes250407 Global Liquidity (One): Interest Rates Are Not the Main Story; Liquidity Is What Matters

This indicator also has certain shortcomings: it is where the problem ultimately becomes visible, in other words, it is a lagging indicator, not a leading indicator—it has no forward-looking value in itself unless its trend is tracked continuously.

Generally, the earliest signs of reserve stress tend to appear at quarter-end, because settlement and regulatory constraints make funding flows tight at quarter-end. The Fed has intervened several times on this issue, attempting to ease the pressure by raising the limit on the Standing Repo Facility (SRF) and keeping funding rates within a reasonable range.But the problem is that, so far, usage of SRF and the discount window has been very low—the market has not truly drawn on this liquidity lifeline.

Over the past six months, the SOFR rate has remained above the federal funds target rate, with frequent fluctuations, indicating that tensions in the repo market are increasing.This means the repo market is already experiencing problems. Either there is a shortage of high-quality collateral, or there is a systemic liquidity shortfall.Either way, the market’s structure is beginning to break down—and the repo market is the “heartbeat” of the entire financial system, so the current situation is genuinely very dangerous.

This is also one reason the Federal Reserve has paused or signaled that it is about to pause QT. Although it has not completely stopped balance-sheet runoff, MBS is still shrinking passively, and Treasuries are also declining by about 50 hundred million dollars a month, liquidity pressures have become a policy priority.

The market is now in a “tools exhausted” phase. The various levers the Fed has frequently pulled over the past four years—such as RRP—have now been almost exhausted, with balances close to zero and only temporary quarter-end funding activity remaining, while TGA cannot provide a lasting substitute, In other words, nearly all the major liquidity levers have now been pulled almost to their limits—a very clear consequence is emerging: this system now needs new intervention tools.

2025.04.09

II. Insights

Our Viewpoints and ideas on market.

If Recession Returns: A Simple Framework for Analyzing Gold and U.S. Treasuries

If the next U.S. recession arrives—whenever that may be—the twin deficits will most likely flare up again. The key question is whether U.S. Treasuries will depreciate against gold at that point.

A simple core framework for judgment based on multiple factors, To reiterate, we are discussing a relative trade here, not absolute performance.：

For further reading: Notes250408U.S. Treasuries/Gold: A Geopolitical Relative-Value Rationale

1. A U.S.-only recession?

If the next possible recession affects the United States more than other countries, concerns about fiscal overextension could cause the market to drive U.S. Treasuries lower relative to gold; if the global economy is “in the same boat,” then UST may retain its value against gold, as it did after the Global Financial Crisis and Covid.

However, the current cyclical positions of China’s economy and markets differ significantly from those of the United States, so a future U.S. recession may not affect China as significantly as it has in the past.

The likelihood of being “in the same boat” is declining sharply; from this perspective, U.S. Treasuries will depreciate relative to gold.

2. Is the geopolitical situation stable or volatile?

If the ongoing Middle East conflict escalates further, geopolitical tensions involving Russia and Ukraine and elsewhere continue to spread, or U.S.-China relations deteriorate (which may first show up in tariff disputes), other central banks may continue to diversify, shifting from UST toward gold, al although diversification itself is already a major trend, geopolitics mainly affects its pace and causes short- to medium-term trading shocks (7-14 weeks).

3. Who will buy large quantities of UST in the next recession and absorb the next wave of Treasury issuance?

As foreign holders reduce their positions, domestic U.S. entities (the Fed, banks, mutual funds, banks, pension funds, and households) have already been increasing their share of UST ownership, For more on this shift toward domestic holders, readers can also consult the article on the Mar-a-Lago Accord.

For further reading: Notes250325The Stillborn Mar-a-Lago Accord

4. Is the petrodollar system robust? This is a question about the Petrodollar.

The dollar is widely used in global oil and gas trade, sustaining natural demand for U.S. Treasuries. Major Middle Eastern oil producers use exchange-rate regimes pegged to the dollar, indirectly turning oil revenues into incremental demand for U.S. Treasuries. If the “petrodollar” mechanism is disrupted, demand for Treasuries may be affected again.

The dollar’s dominant use in global oil and commodity trade increases demand for UST.Major Middle Eastern oil producers maintain currencies pegged to the dollar and, through their dollar-linked exchange-rate regimes, indirectly turn oil revenues into additional demand for U.S. Treasuries; this means oil revenue surpluses indirectly boost demand for UST.If the “petrodollar” mechanism is disrupted, demand for U.S. Treasuries may be affected again.

A good way to observe this is to look at the coordination between oil-producing countries’ policy moves and those of the U.S. ruling party: oil producers like to speak out at certain key moments or suddenly increase or cut production.

2025.04.08

Basis fluctuations are more a symptom than a root cause (Understanding basis trading)

Recent market discussion of the Treasury basis has caused considerable controversy and confusion, In fact, since the basis reversal event in 20, 3, it has often been blamed for causing market volatility.Although basis trading is enormous in scale, for now, exiting by delivering the position into the futures contract can still effectively limit risk.

One. The starting point of the basis problem

Cash managers (what Wall Street calls “Real Money”) would rather invest cash in corporate bonds and structured products to earn higher returns than buy off-the-run U.S. Treasuries.Therefore, They buy basis products and fill the gaps in their Treasury risk portfolios by buying futures.

These purchases by real-money investors push futures prices higher, and therefore Hedge funds (HFs) take the opposite side of the trade, selling futures and buying off-the-run U.S. Treasuries (financing them through the repo market).

So, ultimately, this is essentially an arbitrage pair between LOs and HFs.

Pure basis trading means hedge funds buy the cheapest-to-deliver security (Cheapest-To-Deliver, CTD) for delivery into the futures contract. In practice, however, many hedge funds also choose relative-value trades, buying Treasuries that are slightly cheaper rather than CTD.

Two. So how do hedge funds exit these positions?

Real-money investors’ long futures positions are rolled into the new front-month contract at the end of each quarter. Hedge funds typically take the opposite position at the same time and roll it into a deferred contract.

However, The hedge funds’ short futures positions can also choose to deliver CTD to the futures longs on the delivery date.The delivery option means shorts know they can always exit the position at delivery at a basis of 0—hedge funds The risk of basis trading mainly comes from whether the position can be held all the way to the delivery date(or whether certain factors prevent them from holding the position until the delivery date)..

Three. What happened in 20, 3?

At the time, the futures contract rolled into the new front-month contract at the end of 2, and this was a relatively late delivery cycle (when the coupon on CTD is higher than the repo rate, shorts should deliver at the end of the delivery month; if the coupon is below the repo rate, they should deliver on the first day of the delivery month).

Simply put, when the coupon on the cheapest-to-deliver security (CTD) is higher than the repo rate, the short (seller) chooses to deliver at the end of the delivery month. This is because the cost of holding CTD is lower, making delivery more profitable. If the coupon is below the repo rate, the short chooses to deliver on the first day of the delivery month because that reduces the cost of holding.

When the pandemic brought the global economy to a standstill, delivery was still 3 and a half months away. Many traders switched to working from home, and market participation and liquidity both fell sharply. The original delivery horizon (delivery 3 and a half months later) then seemed very long, especially amid a sudden global crisis, when investors could not accurately predict the market’s direction or risks.

In this situation, investors’ demand for safety made U.S. Treasury futures (long-term debt) outperform off-the-run U.S. Treasuries, changing the profit and loss of basis trades.

The basic logic of basis trading is the price gap between the futures market and the cash market, and amid market turmoil, some hedge funds (HFs) concluded that basis trading was no longer profitable and had to close out their positions, while These position liquidations caused further market volatility and put pressure on other hedge funds.

These liquidations caused sharp market price swings, pushing basis-trade prices to historical extremes. In the process, institutions able to step in quickly and take the other side successfully earned a profit of 1/3 to 1/2 basis points by holding the futures position through delivery.This is because they knew that as long as they held on until delivery, prices would return to reasonable levels. Once the Fed began buying Treasuries, these investors exited the market more quickly and locked in their profits.

Four. Is there a risk of a repeat today?

Although crowded leveraged positions may increase the risk of a disorderly reversal in the market, the risk of basis trading is fundamentally still relatively small compared with other crowded positions, because the delivery mechanism provides a backstop (in the worst case, the position can be held to maturity).

Additionally, for most futures contracts, delivery takes place on the first day of 6. This means that those currently holding these positions know they need to hold on for only another 7 and a half weeks before they can exit at delivery at a basis of 0.

Even with poor liquidity and reduced risk tolerance, if there is a severe wave of liquidations, someone will most likely still step in quickly and take over the trade. Therefore, The time remaining until delivery is a key factor in basis risk.

This also means that trying to blame this week’s volatility on the Treasury basis is a fallacy.The turmoil this week was actually a problem of intermediation capacity...

These intermediaries (mainly dealers) did not have enough balance-sheet capacity to absorb the forced Treasury selling by U.S. equity-market investors after the S&P 500 index fell 6% on Friday. That is, Many institutions with positions in U.S. equities sold Treasuries to meet margin requirements, creating selling pressure in the Treasury market. Dealers, lacking liquidity, could not absorb these sales, further amplifying market volatility.

Basis fluctuations are more a symptom than a root cause. Ultimately, the problem lies with balance sheets and liquidity; we will explore this further in our liquidity series. After reading this article, you will understand: don’t mistake the secondary issue for the main one—focus on what matters.

2025.04.10

III. Market Pulse

Our latest Comments on the economic and market environment

This round’s CNY depreciation + why we are continuing to hold the two trades mentioned earlier

USD/CNY broke through the 7.3 level, signaling room for further depreciation of the renminbi. The strategy remains to short high-beta currencies and go long the Swiss franc and yen. There has been extensive discussion of this on the community platform, so we will not list it all here, We explained the logic behind these two trades 1-2 months ago. They have now entered the profitable stage, so there is no rush to close them.

It is worth noting that, This round’s depreciation of CNY against USD differs from the situation during the trade war in 2018:

Although the dollar has weakened against most major currencies and gold since 2025, the renminbi has continued to depreciate. 7.3, a key resistance level that served as support several times over the past few years, has now been breached, which is highly significant.

In 18, the renminbi’s weakness coincided with broad dollar strength. This time, however, it is not driven by a stronger dollar or a widening U.S.-China interest-rate differential; instead, it has a more structural character, reflecting heightened economic vulnerability and renewed escalation in external trade pressures. After China retaliated against the “Liberation Day tariffs,” the U.S. government announced an additional 50% tariff on imports from China, reigniting trade tensions.

Domestically, the economy is currently mired in deflationary pressure, It is inevitable that policymakers will step up stimulus, although the authorities continue to stress the importance of exchange-rate stability, at present it is indeed It is highly likely that they will continue to tolerate further depreciation of CNY to 7% by 5%, partly to offset the impact on exports to the United States.

If things do continue to unfold as we expect, the weakening of CNY will continue to pressure high-beta developed- and emerging-market currencies, while further strengthening the performance of safe-haven currencies such as the Swiss franc and yen, This is why, as stated at the outset, there is no rush to close these profitable trades，In the first round, these trades were based on U.S. fundamentals; now we are in the second trading cycle, based on our side’s policies. When the policy measures have run their course, it will be time to close the positions for a profit.