Needless to say, under-positioned discretionary investor cohorts were in an uncomfortable position this week.

On the eve of what all but the most tortured, pessimistic souls assumed would be a budget deal in D.C., equities were near the top of the range they’ve plied for months, and looked poised to break out. More colloquially, 2023’s narrow, tech-driven rally was threatening to escape the lab.

That made “FOMO” a fixture of the daily market banter. The discomfort among those still offsides and therefore needing to add length was made worse by the prospect of a debt ceiling agreement which, even if it becomes a “sell the news” event, and notwithstanding the very real potential for the ensuing deluge of bill issuance to drain liquidity to the detriment of risk, still had the potential to trigger a short-lived relief rally.

That’s the setup. Assuming a deal gets done, what comes next? Well, it’s all about sequencing, and it’s natural to assume that news of a deal would be initially met with cheers from Wall Street. After that, the nuance becomes important.

A “capitulatory ‘stop-in’ ensues from the majority of remaining bearish fundamental / active / discretionary holdouts who’ve been fighting and losing,” Nomura’s Charlie McElligott wrote Tuesday, describing the likely knee-jerk reaction to a deal. Any such impulse could be amplified by the unwind of left-tail hedges (i.e., in equities downside and VIX upside). The accompanying decline in vol could then trigger more exposure adds from a systematic crowd which has been a large source of buying since the lows six months ago.

After that, though, upside for equities could be capped by the liquidity drain dynamic and, importantly, the Fed, which would likely view a resolution to the debt ceiling drama as a green light to indulge any hawkish inclinations officials might be harboring in light of still onerous inflation realities.

“The first consequence [of a deal] is that the Fed regains its leverage in sustaining ‘higher for longer’ into a still uneven US economy, where labor and inflation continue [to be] stickier than they’d like,” McElligott said, noting that in that scenario, the odds of the Fed holding terminal through year-end would increase, while black swan-inspired easing probabilities (priced deceptively as a series of “calm” 25bps cuts) would surely diminish.

Remember: The Fed typically holds terminal for around seven months, and given how stubborn inflation is proving to be, you’d be inclined to think they’d hold rates in restrictive territory for longer this cycle, the polar opposite of the quick about-face ostensibly priced by markets.

The second consequence is the widely discussed liquidity drain. “The ongoing siphoning from QT alongside the persistent trend into money market / RRP [would] then get super-charged, as the Treasury may issue anywhere from $500 billion to $700 billion of T-Bills in the weeks following a hypothetical debt-ceiling resolution,” Charlie went on, cautioning that “as this T-Bill supply shock risks pressuring rates higher and bleeds out into repo / collateral chain, there can then be a negative portfolio rebalancing effect as you push into (wider) spread product and further out onto the risk curve, i.e. equities.”

Of course, that’s widely socialized now. Rates get it, even if equities don’t (or don’t care). So, it’s possible some of the liquidity drain dynamic is already in the price. Just not in stocks.