Macro and Flows Update: August 2023 - e20
Summary
TLDRThe video discusses the macroeconomic liquidity situation, highlighting the significant decrease in liquidity due to the expected $1.2 trillion dollar issuance over the next 6-9 months. Despite this, recent bank runs and TGA drawdowns have temporarily increased market liquidity. The video also touches on the Biden Administration's strategy to accelerate debt issuance to avoid liquidity issues during the election period. It further explores the role of structured products in creating a substantial implied volatility supply, which has historically supported the S&P 500. The speaker predicts potential market rotations and emphasizes the importance of monitoring the 10-year yield and positioning in the bond market, concluding with an outlook on market behavior leading up to Labor Day and the potential for a buying opportunity post-Labor Day.
Takeaways
- 📉 The liquidity from a macro perspective is decreasing, with an expected $1.2 trillion in debt issuance over the next 6-9 months.
- 📊 Despite talk of quantitative tightening (QT), liquidity models have remained supportive, reflecting the complex relationship between macroeconomic factors and market liquidity.
- 💹 The February-March bank run and the debt ceiling TGA drawdown significantly increased market liquidity, but this trend is now reversing.
- 🛑 The Biden Administration and the Treasury have recognized the need to balance debt issuance with the potential impact on market liquidity, especially ahead of the election period.
- 📈 The market has shown resilience despite liquidity divergences, as seen in the period leading up to the COVID crash in 2019-2020.
- 📊 The correlation between liquidity and demand for stocks is strong, indicating the importance of macro liquidity for asset prices.
- 🌐 International factors, such as Japan's interest rate policy and credit rating agency downgrades, can influence the US market's liquidity and investor sentiment.
- 🔄 The issuance of Structured Products has increased, offering investors an alternative to the stock market with high yields and lower risk.
- 📊 Implied volatility supply is well-supplied, creating a pinning effect on the S&P 500 and supporting market stability despite underlying dispersion.
- 🔄 Market rotation and dispersion are expected to continue, with significant moves in various market sectors and asset classes.
- 🚨 The upcoming period until Labor Day is critical, with potential for market volatility if the current implied volatility supply dynamics change.
Q & A
What is the primary focus of the macro and flows update video?
-The primary focus of the video is to discuss the changes in market liquidity from a macro perspective, the impact of debt issuance on the market, and how these factors influence the demand for stocks and other assets.
What does the term 'TGA' refer to in the context of the video?
-In the context of the video, 'TGA' refers to the Treasury General Account, which is the account held by the U.S. Treasury at the Federal Reserve where government funds are deposited and from which payments are made.
How did the February-March bank run and the debt ceiling TGA drawdown affect the market?
-The February-March bank run and the debt ceiling TGA drawdown resulted in a significant amount of liquidity being pushed into the market, which initially supported the market despite the potential for liquidity to decrease due to interest rate increases and other macro factors.
What is the significance of the $1.2 trillion in debt issuance expected over the next six to nine months?
-The expected $1.2 trillion in debt issuance is significant because it represents a large decrease in liquidity, which could impact the demand for stocks and assets. This figure is a key consideration for investors and market participants when assessing future market conditions.
How did the Biden administration and the Treasury respond to the anticipated increase in debt issuance?
-The Biden administration and the Treasury began to increase and accelerate the amount and duration of debt issuance to avoid drawing liquidity at unfavorable times, such as early to mid-next year coinciding with the election period.
What is the role of structured products in the current market environment?
-Structured products have been increasingly appealing as they offer high yields (9-10% per year) with relatively low risk and non-correlation to the equity market. They serve as an alternative to the stock market, which is seen as overvalued and risky, and they contribute to the supply of implied volatility, impacting market dynamics.
What is the ' dispersion ' mentioned in the video, and why is it significant?
-Dispersion refers to the difference in volatility between the constituents of an index and the index itself. High dispersion levels, as seen in the S&P 500, indicate that individual stocks are moving more dramatically than the index, leading to significant rotation and shifts in market trends.
How does the issuance of structured products impact the implied volatility market?
-The issuance of structured products contributes to a high supply of implied volatility, as they are often constructed to sell volatility. This increased supply creates a pinning effect on the market, particularly the S&P 500, providing underlying support and stability despite individual stock volatility.
What is the potential impact of geopolitical issues on the macro liquidity situation?
-Geopolitical issues can introduce uncertainty and risk into the market, potentially leading to shifts in macro liquidity. Depending on the scale and nature of these issues, they could be strong enough to disrupt the current stability of the market and lead to significant changes in market dynamics.
What does the video suggest about the market's response to the upcoming Labor Day period?
-The video suggests that the period leading up to Labor Day is critical, as it is a time when significant market shifts can occur due to the expiration cycle and the potential for increased market volatility. Investors should be vigilant and prepared for possible rotations and changes in market trends.
What is the significance of the 10-year yield in the context of the video?
-The 10-year yield is significant as it reflects the market's expectations for inflation and growth. The video discusses how movements in the 10-year yield can indicate shifts in market sentiment, such as the move to 4.1% reflecting an inflationary trend. Watching this yield closely can provide insights into future market behavior.
Outlines
📉 Macro Liquidity and Market Implications
This paragraph discusses the macroeconomic perspective on liquidity and its impact on the market. It highlights the significant decrease in liquidity due to the draining of the Treasury General Account (TGA) and the expected large-scale debt issuance over the next six to nine months. The speaker notes that despite talk of quantitative tightening (QT), liquidity models have remained supportive. However, the February-March bank run and the subsequent TGA drawdown have injected substantial liquidity into the market, which is now starting to diminish. The paragraph also touches on the Biden Administration's strategy to accelerate debt issuance to avoid a liquidity crunch during the election period.
💹 Market Flows and Structural Product Trends
The focus of this paragraph is on market flows and the role of structured products in the current financial landscape. It emphasizes the supportive role of flows, especially in the context of slower issuance and shorter duration, which has helped markets levitate. However, the speaker warns that this support cannot last indefinitely. The paragraph also discusses the issuance of structured products that offer high yields and serve as an alternative to the overvalued and risky stock market. These products are seen as a way to deleverage from equities and are becoming increasingly popular due to their non-correlated, relatively low-risk nature.
📈 Implied Volatility and Market Dynamics
This paragraph delves into the concept of implied volatility and its effect on the market. The speaker explains how the high issuance of structured products has led to an oversupply of implied volatility, which in turn creates a pinning effect on the market, particularly the S&P 500. This pinning effect provides underlying support, making the market very sticky. The speaker also discusses the dispersion of volatility among the constituents of the indices, which is significantly higher than the index itself, leading to a breakdown in correlation. The paragraph highlights the historic levels of dispersion and the potential for continued significant rotation and dispersion in the market.
🔄 Market Rotation and Positioning
The speaker discusses market rotation and positioning, emphasizing the importance of understanding where the market's focus lies. The paragraph covers the expected rotation from the NASDAQ to the Russell and the counter-trend observed since February-March. It also touches on the bond market and the potential for a steepening trade due to the backwardation of the yield curve. The speaker advises watching the 10-year yield and positioning in bonds, as well as the conversations around deflation versus inflation. The paragraph concludes with a discussion on the potential for a significant market shift if macro liquidity issues arise from international phenomena.
🚨 Risk Management and Legal Disclaimer
This final paragraph serves as a legal disclaimer, emphasizing that the content of the video does not constitute an offer to sell or a solicitation of an offer to buy any security or other product or service. It clarifies that the information provided is not intended to provide tax, legal, or investment advice and should not be construed as a recommendation to engage in any investment strategy or transaction. The speaker reminds viewers that they are solely responsible for determining the appropriateness of any investment strategy or security based on their personal investment objectives, financial circumstances, and risk tolerance, and encourages consulting with business, legal, or tax advisors for specific situations.
Mindmap
Keywords
💡Liquidity
💡TGA (Treasury General Account)
💡Debt Issuance
💡Quantitative Tightening (QT)
💡Bank Run
💡Structured Products
💡Implied Volatility
💡Risk Parity
💡Market Rotation
💡Yield Curve
💡Market Pinning
💡Seasonality
Highlights
The discussion revolves around the macroeconomic liquidity situation and its impact on financial markets, particularly in August.
Liquidity models have remained supportive despite talks of quantitative tightening (QT) and potential drains from interest rate increases.
The February-March bank run and the debt ceiling TGA drawdown resulted in a significant amount of liquidity being pushed into the market.
There is an expectation of $1.2 trillion in debt issuance over the next six to nine months, indicating a large decrease in liquidity.
The beta for liquidity over the last five to six years has been around 97, showing a strong correlation with the demand for stocks and assets.
The Biden administration and the Treasury began to increase the amount and duration of debt issuance to avoid drawing liquidity at unfavorable times, such as the election period.
Japan has allowed its interest rates to rise, reflecting concerns about the US issuance and the global liquidity situation.
Fitch and Moody's have downgraded US debt, which is a symptom of the larger macro liquidity issues.
Structured products have seen a dramatic increase in issuance, with a focus on selling volatility, which is a new phenomenon not widely discussed.
These products offer high yields and are seen as an alternative to the overvalued and risky stock market, contributing to a significant rotation out of equities.
The dispersion of volatility among the constituents of the S&P 500 is high, leading to significant rotation and a breakdown in correlation.
The supply of implied volatility is strong and owned by dealers, which creates a pinning effect on the market, particularly the S&P 500.
The market has seen large moves in individual assets like oil and tech stocks, while the index itself remains relatively stable.
The discussion suggests a potential rotation from large-cap to small-cap and from growth to value stocks.
The bond market is also expected to see significant moves, with the 10-year yield potentially breaking out and posing risks.
The positioning in the bond market is not as extreme as it was during the previous move to 4.1%, suggesting a different outcome may occur.
The potential for a significant market event is discussed, with various geopolitical and macroeconomic factors that could influence it.
The period leading up to Labor Day is highlighted as a critical time for market movements and potential liquidity issues.
The video concludes by emphasizing the importance of staying vigilant during the options expiration cycle and the potential for a buying opportunity after Labor Day.
Transcripts
hello and welcome back to another macro
and flows update
video here we sit at August
expiration um as we've talked about now
for uh almost two months the liquidity
from a macro perspective um is coming
off the table when we first addressed
this issue post debt ceiling um we spoke
about the the draining of the TGA that
happened prior and the new issue that
would be coming in debt going out uh for
the next 9 months by a lot of estimates
the next six to9 months would uh at that
time would have expected $1.2 trillion
doar of
issuance um this is clearly a large
number uh and significant decrease of
liquidity coming off the table most
liquidity models have really gone
sideways to actually been quite
supportive despite all the talk of qt or
early on in the year um and all the
potential drain and interest you know
from interest rate increases but the
reality is that the Feb March Bank Run
followed by the debt sealing TGA
drawdown drew a pushed a significant
amount of liquidity into the market um
until really late
June now as we've been saying liquidity
is coming off the table if you look at
liquidity there's a lot of graphs going
around there's a lot of analysis um over
a monthly basis at least beta to
liquidity for the last five six years
has been 97 or so it's dramatically in
line the problem with that is actually
there are several kind of monthly
periods quarterly periods where it does
diverge eventually they come back into
line uh in particular we saw this in uh
2019 uh in the 9 months
preceding uh the covid crash there was a
significant Divergence liquidity was
coming off the table but the market
continued to
rally um that of course came back into
line uh when when we saw the covid crash
in
2020 um so these things can diverge for
a while we've known this it's not a
straight line that said over the long
run as that beta indicates liquidity in
it from a macro perspective is a direct
uh indicator of demand for uh stocks in
particular and assets r large large and
is very important so not a surprise here
two months later that at first the TGA
refill was slow there wasn't much talk
about it the uh the treasury lowered the
duration of what they were issuing um so
it went into reverse repo instead of
being complete drain on on uh aggate
Market liquidity um on top of that uh
they uh the amount of issuance was
decreased early on they were trying to
be conservative in the early steps but
what became clear and clear is that the
administration the Biden Administration
and treasury yelling began to realize
that the amount of issuance which was
going to be quite a bit bigger than they
originally thought uh if they waited too
long would potentially draw liquidity at
exactly the worst time which is early
early to mid next year um and uh right
into an election period so not
surprisingly they began to increase and
ex accelerate not only the amount of
issuance that's coming but on top of
that the duration um of the
issuance that in about a month ago was
the first sign uh when that news came
out that that the markets would have to
take this more seriously more on a
sooner basis um again we talked about
this this isn't new it's just a matter
of uh reality sinking in on top of that
we started to see Japan allow its
interest rates themselves to begin to
rise um because again if if that much
issuance was happening on the US side
there's just not enough liquidity and
the dis uh the amount of difference
between the two would have to be
regulated this also began to concern
markets almost a month ago three weeks
ago on top of that we started to see
Fitch downgrade US debt on the back of
this and now Moody's downgrade Banks um
with much greater War wargs behind it
all of this is not new information it is
simply the symptoms of what we've been
talking about in the bigger macro
liquidity issues that lie ahead that
negative macro though has been balanced
by the flows um the flows have been very
very supportive uh especially in the
context of a slower issuance a shorter
duration and still was able to help
markets levitate a bit there in uh July
and um you know even uh some of the
early part uh sorry in late June as well
as July um however that can only go so
long um not a surprise here again that
we have hence with the flows that have
still existed during this v a charm
period the the buyback uh of stock at
the beginning of the month uh for
reinvestment uh based on a higher
collateral
we have seen what looks like stairsteps
and it's been very very supportive
until expiration week the week we've
highlighted right the Monday and
Wednesday periods right uh you know
after Monday was the beginning of of you
know the end of the strongest point and
of course Wednesday uh of expiration
being the last kind of harah of those
big flows and what have we seen a
significant uh decline now and
acceleration importantly the market um
as we get to these windows that we've
highlighted uh proactively um a month or
so
out
um this is how it works it's a
tug-of-war between flows and macra what
becomes interesting is when the flows
given some downside momentum potentially
reduction in collateral at the end of
the month and and also some of the
momentum factors that come from uh not
only past massive investment but also uh
from from some of the other uh Trend
following risk parity VA targeting
strategies if those flows begin to not
be as supportive um that can turn the
tide and go along with macro and
exacerbate some of the declines that are
coming what holds the key here
ultimately whether we can sway these
markets to a a real Vol event in
liquidation at this point we'll be a
function of implied volatility Supply
itself implied volatility Supply as
we've highlighted has been incredibly
well supplied not just because more V
selling is happening by speculators and
funds and there's less hedging and
buying broadly by others but more
importantly than that because of
Structured
Products there is a phenomena that
nobody else is talking about but us here
that nobody else has done the research
on except for what we've seen
but we are seeing a dramatically higher
issuance of Structured Products of which
are overwhelmingly selling B why is that
happening because Structured Products
build upon a risk-free yield in times
past when we had inflation and Rising
interest rates money would flow to bonds
exclusively there were no Structured
Products in the 70s there were no
derivatives or options in the
70s and so the money would simply flow
to bonds the reality though is bonds can
be invested and used as collateral and
leveraged for other uh risk layering
yield stacking however you want to uh
refer to it and this creates the ability
to structure products at incredibly
desirable percent yields that are
non-correlated that are relatively low
risk and an incredible way to delever
from the equity market so these have
been incredibly appealing some of these
yeld 9 10% per per year for the next two
years while selling you know by putting
being put back into the market 25 30%
lower being you know shorting the market
at 25 to 30% higher while still having
that 10% payout in between um those
types of uh alternatives are um again
incredibly appealing not only because
they yield that high in amount now but
because they serve as an alternative to
to the stock market which itself is seen
increasingly as overvalued and risky
after 2 years of significant
volatility without any returns again uh
after 12 years of significant 12% on
average returns after 09 I'm not a
surprise that uh we're starting to see
overvaluations and a need to move
away but unlike during the 70s ' 80s
moving money to bonds doesn't compress
volatility money moving to Structured
Products creates massive Vol Supply gets
which is owned by dealers particularly
Banks who then pass it on to market
makers and other others who have to
Warehouse it in the market this implied
volatility which is tied in the S&P 500
in particularly in the equity Market
creates a pinning effect um an
underlying support to the market that
ultimately is is very very sticky
because most of the supply is not weak
hands it is simply deleveraging from the
equity Market um and the supply as I
mentioned is dramatic because it's
coming from significant delevering from
the whole Equity Market
itself this Vol Supply um has been the
single Dutch boy with his thumb in the
Dyke that we've alluded to in the S&P
500 and it is so strong with volatility
increasing on the exterior for the last
several years in particular the last 6
to n months that we've gotten historic
what we call dispersion the underlying
con constituents of the indices are
moving um uh in line with historic
precedent which is quite significant uh
with these with these flows while the
index itself is fairly pinned that means
the volatility of the constituents is
much higher than the index um and the
correlation between things is breaking
down significantly we highlighted that
this happened in 2017 last um at that
time implied V was much more compressed
and realized v um on the single list was
still quite High relative to implied VA
but it generally speaking realized
implied VA was significantly lower much
less liquidity issues much less uh risk
from a macro perspective very different
macro environment at the time um but
that was the greatest highest amount of
dispersion profits we had ever seen um
and the and the highest amount of
dispersion and and breakdown and
correlation ever in 125 years and we're
now at that level which speaks the
amount of B Supply and the opining
that's happening in the S&P so very
important to understand that um what
that means because that's likely not to
get uh easily broken is that we are
likely to see continued significant
dispersion significant
rotation uh this is the major driver
that has made to see leptokurtic moves
across the market while the index itself
has been relatively subdued for years
now we are seeing we've seen dramatic
moves in oil from -30 to 20 plus uh
we've seen dramatic Moves In in uh the
decline in Tech uh in 2021 through 2022
only to see a dramatic counter move
since February of this year and that
growth to Value um not to mention large
cap to small cap uh breadth uh going to
Historic levels as well the fact that
these tail events on the taals of the
market continue to fly around while the
index itself uh maintains its stability
is a tribute to how strong that single
Dutch boy with his thumb in the Dyke
that V Supply in the S&P 500 um has been
so strong um that does not mean uh the
cracks aren't building that the pressure
and the potential energy behind the dam
aren't building um but it does mean that
that Dutch boy is wellfed and that
ultimately he is uh able to hold
continue to hold at Bay those liquidity
pressures so continue to look for
rotation and dispersion when things get
too s far on one side of the boat we
were obviously quite preent uh last um
month um in in calling for the
significant beginning of a rotation from
the NASDAQ back into the Russell u a
counter trend from what we've seen since
February March and of course we
highlighted that here on those videos as
well the initial Tech rally relative to
the Russell put that we expected um and
so we've really been able to nail those
dispersions uh those rotations and we uh
that really is simply looking at
positioning and seeing how far people
are on one side of the boat for these
Trends um at the same time we believe
something similar is happening in the
bond market the last time we saw the
10year move to
4.1% um we it was very clear that was a
secular Trend at that point
and everybody was on the inflationary
Train everybody was too far on one side
of the boat that doesn't mean the
secular Trend wouldn't continue but it
made for a situation where the simplest
smallest little excuse right for that to
that to rotate back down uh was was
highly likely um to cause some problems
and that's what we saw with the bank run
in February into March and we saw a
dramatic decline very sudden almost
historic move in uh long duration bonds
during that window but we were very
clear in that window as well here on the
macro and flows that we would expect
that to be a low and that for a
steepening trade at that point to be a
historically profitable trade given the
backwardation of the yield curve um and
that again is what we've seen as uh
interest rates in the 10 year have gone
from below around 3% right back to that
uh uh those those recent all-time Highs
at 4.1 to 4
.2% and uh we believe now the
positioning is not nearly where it was
last time around if anything the
deflationist got too far on their side
of the boat and now this has the
potential to break out and if it breaks
out there is significant risk given the
issuance that we just talked about at
the beginning of this conversation for
it to be particularly big and ugly given
the treasury will have to continue to
push against that without many
Alternatives so look for that to be an
important part of the puzzle watch the
10-year yield watch what happens to
those yields watch positioning in the
bonds and the conversations around
deflation versus
inflation ironically I think we begin to
see that recessionary talk come up again
if markets begin to decline here and if
that happens that will allow for
positioning not to build to be so strong
and we believe ironically
counterintuitively that will allow the
potential supply and demand and balance
to continue for that steeping
trade so NASDAQ should continue to be
weak into that window uh dur duration
should do quite well in the uh debt
markets um uh well quite poorly I
apologize the yield should go higher um
and ultimately we believe the S&P VA
will still maintain its pinning into
this decline the question
is could we potentially see enough macro
liquidity issues for wall to become un
and pinned from a international
phenomena something on the tail that's
bigger that we're not quite sure what
that is is it China and the yuan is it
Japan and and uh their interest rates um
is it something coming from Europe um
and and and the market there um any one
of these things not to mention the
geopolitical issues could be strong
enough to shake that macro SMP um VA
positioning and if it
does that would be an overwhelming tidal
way there's essentially 3 weeks until
Labor Day for that to
happen um and it's a short window for it
to begin but this is the window it needs
to happen in because much like that day
after after February that the covid
crash began and ended the day after the
March uh the day after March Opex here
we are going into a quarterly Opex is
the last and final important thing that
corly Opex means massive open interest
massive risk these are the periods
particularly at the beginning of these
expiration cycle Cycles where things can
really have a problem if we can break
that Vol Supply if we can begin to see a
liquidation that really takes on speed
in on
pinville um this could
potentially continue to roll over and
get significantly worse but if V Supply
doesn't crack in this
period um which seems increasingly
likely even if we get a continued stair
step down
decline we would expect by by the time
you get to uh
CPI uh after Labor Day that this would
ultimately just become another buying
opportunity and supported uh environment
uh for markets with sep as we go into
sep expiration more and more buyback
from Vana and charm and ultimately begin
to take us into the stronger seasonal
period uh eventually November December
January where V itself um accelerates
its Decay because of the number of
holidays and the number of volume
weighted decrease in time as people take
uh more and more time off not to mention
maybe most importantly if markets
continue to be up significantly on the
Year by the time we reach late
October it is fair to say that the
amount of collateral reinvestment for
the end of the year is so massive that
it could counterweight all of the
liquidity drain that we're seeing um and
very much lead to not only a support but
a counter Trend bounce back up until mid
January after for the January effect so
stay on your toes is a critical 2 and
1/2 three weeks as I always say be water
and good luck in the SE expiration cycle
thank
you this does not constitute an offer to
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construed as a recommendation to buy
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or to engage in any investment strategy
or transaction Kai does not represent
that the Security's products or services
discussed in this video are suitable for
any particular investor you are solely
responsible for determining whether any
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