Before the A.I. frenzy shifted into overdrive, rally skeptics explained equity market resilience by way of an ex-US global liquidity impulse.

The narrative went something like this. Bond-buying by the Bank of Japan along with PBoC lending and ECB draws helped offset Fed QT, resulting in a net increase in global liquidity. That was the “oxygen” that allowed stocks to stay alive in the “death zone,” as Morgan Stanley’s Mike Wilson put it in February, using a mountaineering analogy.

Post-SVB, some argued stocks found support from a kind of false optic around Fed balance sheet expansion tied to borrowing from the discount window and the newly-created Bank Term Funding Program as well as FDIC-related line items associated with the regional bank turmoil.

Bottom line: Bears blamed liquidity. Now they blame A.I. Both explanations have merit, but past a certain point, “blame” is just another word for “excuse.” There’s a fine line between the two when it comes to explaining away rallies.

Going forward, liquidity will be front and center again (not that it’s ever unimportant), only this time it should be a headwind for risk. The tsunami of bill issuance that’ll hit following an assumed resolution to the debt ceiling standoff in D.C. will play out alongside the ongoing deposit-to-money market fund shift, and that’s to say nothing of APP reinvestment cessation and TLTRO maturities in Europe, as well as the de facto liquidity drain from the resumption of student loan payments in the US.

How that all comes together is a hot topic. I’ve explored it at length on several occasions, including a few days ago in “The Debt Ceiling Double Paradox”+, but given the attention it’s garnered, it’s worth highlighting a few passages from JPMorgan’s take, which also folds in some of the global dynamics mentioned above.

“Once the debt ceiling negotiations are concluded, the rebuilding of the TGA balance toward its medium-term level of around $600 billion to $700 billion will likely proceed relatively quickly,” the bank’s Nikolaos Panigirtzoglou wrote, noting that “the net effect of the TGA rebuild and QT on broad liquidity is clearly negative.”

In the US context, JPMorgan defines broad liquidity as M2 and institutional money market fund assets, and it’s been contracting since Q4. So far in 2023, the pace of that contraction is around 5%. The bank, like most observers, expects the lion’s share of the forthcoming T-bill issuance to be absorbed by the non-bank private sector (not money market funds exiting RRP).

“If we project broad liquidity assuming that the bulk of the TGA rebuild drains reserves and deposits and account for QT this would suggest a YoY decline in broad liquidity of more than 6%,” Panigirtzoglou went on, pointing to the red diamond in the figure on the left below.

That’s a meaningful contraction. If you measure from year-end 2022 and extrapolate through the end of this year, it comes to around $1.7 trillion. While Panigirtzoglou said loan growth could mitigate the impact, recent developments in the banking sector suggest any such offset would be partial, at best.

What about global liquidity? After all, we saw first-hand how the Fed QT headwind can be offset by an ex-US liquidity tailwind to the benefit of equities from October through mid-February. Unfortunately, the news isn’t great there either. The figure on the right above suggests global broad liquidity ex-US and China has flatlined.

“In the euro area, bank liquidity has also been reduced by the €1 trillion decline in TLTRO borrowing since November amid prepayments and maturities,” Panigirtzoglou wrote, pointing to nearly a half-trillion euros in outstanding TLTROs which will mature at the end of next month. “While this drain on reserves does not directly reduce broad liquidity… there has been a contraction in euro area M2 by around €240 billion from its peak, which suggests a potential indirect impact.” That’s on top of ECB balance sheet runoff.

Panigirtzoglou summed it up. “With contraction in broad liquidity in the US looking unlikely to be offset by the rest of the world, this looks likely to present a headwind for financial assets from a flow perspective, as the contraction in broad liquidity means there is less cash to propagate financial assets,” he said.