Even if Treasury’s cash rebuild ends up funded primarily through RRP transformation, the liquidity backdrop will be less forgiving going forward, and that should be expected to weigh on equities all else equal.

Of course, all else is never equal. Not even close. Stocks are highly susceptible to fits of mania and bouts of despair. Ironically in that context, they can also be hostage to unemotional shifts in systematic flows dictated by momentum signals, portfolio vol and other mechanical triggers. Fed rhetoric can hijack the price action, so can geopolitical developments, macro surprises and so on.

In short: It’s impossible to predict what stocks will do in the near- to medium-term. Everyone knows that, but everyone nevertheless tries to make predictions anyway, and in many cases we lose money in the process. Stock forecasting reminds me a bit of golf in that regard. As Will Ferrell put it during his famous audition for Saturday Night Live, “Golf’s a funny game isn’t it? It’s hard, it’s expensive and yet we keep playing it.”

For argument’s sake, let’s hold all else equal and assume a relatively benign outcome to the TGA refill, where “benign” means most of the funding comes out of RRP, not reserves. That’d be consistent with how things are developing in the early stages, as detailed in “The Status Of The ‘Liquidity Drain’ Bear Case”+.

Morgan Stanley sees around $1.2 trillion in issuance over the next six months across bills and coupons, and the bank’s Mike Wilson on Tuesday acknowledged what everyone with even a passing interest in this all-important question has conceded over the past several days — namely that the refill is for now a “so far, so good” story, as BNY Mellon’s John Velis put it. But we’re not out of the woods.

“Issuance got under way last week with a large portion being funded by RRP. While that may continue, our rates strategy team believes a good chunk of that funding will come from bank reserves — up to $500 billion,” Wilson reiterated.

What does that mean for stocks? Well, again, it’s impossible to know, but as Wilson went on to write, equities don’t generally trade well “when we see such a drawdown in bank reserves.” The scatterplot on the right above gives you some context.

The problem here is twofold. First, this has to be considered on top of various other factors, and not just dynamics associated with acronyms that most investors can’t readily unpack (e.g., APP and TLTRO). Student loan payments in the US will restart in a few months, for example. In addition, the expiration of expanded SNAP benefits is already having an impact on low-income consumers according to Dollar General, which knows a thing or two about that cohort.

“[F]iscal support is likely to turn into a 2% drag starting in August [which] would amount to an approximately 6% drag to nominal GDP growth over the next 12 months,” Wilson said, citing Morgan’s rates team again. “Given the recent debt ceiling deal that puts caps on additional fiscal spending, this seems like a major headwind to growth that many aren’t baking into their estimates.”

He suggested that even a relatively modest additional decline in reserves associated with the TGA rebuild could be a “wake-up call” for an equity market which appears to be ignoring not only the more challenging fiscal outlook in the US, but also the less favorable backdrop for USD M2 growth globally.

“Either global M2 growth is about to surge or else stocks have a long way to fall to get back in line with this metric,” Wilson remarked, referencing the figure on the left above.

Second, there’s no guarantee that the “so far, so good” characterization of the RRP/reserve split vis-à-vis Janet Yellen’s efforts to refill the Treasury’s coffers will still apply a month or two or three from now.

“Given that the RRP facility has drained significantly over the last week or so, we might be tempted to think the additional issuance to come over the rest of the year will be easily financed by this transformation of RRP into bills [but] we caution that this might not be the case after the summer, or even in July and August,” BNY Mellon’s Velis wrote Tuesday.

The figure above shows bill yields with the RRP rate assuming a July hike. The implication is clear enough.

“Not until Fed policy uncertainty is behind [us] should we expect to see any further big moves out of the overnight facility,” Velis said. That “suggests there will be pressure on reserves going forward.”

The more pressure on reserves, the worse for equities through the (admittedly nebulous) liquidity channel. All else equal, of course.