This is a note from Prometheus Institutional.
As US equities continue to push higher on the back of earnings expectations for technology firms, we think it will become increasingly important to monitor financial stability measures that underpin these expectations. Put differently, financial system liquidity conditions will be an important input in determining whether the equity market rally can continue or will stall out. We share our tracking of US liquidity conditions:
We begin tracking liquidity conditions by presenting the weighted growth rate of the major sources of liquidity: reserves, commercial paper, & repurchase agreements. In the modern era, the primary sources of financial system liquidity have collapsed to two sources: private sector repo and banks’ reserve balances. We zoom in on these sources below:
As the Federal Reserve has rolled off its quantitative easing programs, reserve balances have become a much less meaningful driver of financial system conditions. We show how the factors contributing to reserves have been flat/modestly negative since 2024:
Given these dynamics, rep activity has been the dominant source of new liquidity for the financial system. We show the evolution of private repo growth by type below:
