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Market liquidity has fallen by $150 billion since Congress suspended the debt ceiling earlier this month, according to institutional brokerage and advisory firm Strategas.
In a note Thursday, Strategas attributed the decline to the Treasury Department's issuance of debt and the Federal Reserve's quantitative tightening program to shrink its balance sheet.
The debt ceiling deal cleared the way for the Treasury Department to auction more T-bills, which will restore the government's cash balance.
But the money to buy those T-bills comes out of financial markets, and Strategas said the Fed's reverse repurchase program — which acts like short-term loans — isn't offsetting the loss of liquidity from the auctions.
Meanwhile, the Fed began its quantitative tightening program a year ago, letting bonds roll off its balance sheet as they mature. But Strategas said federal spending via the Treasury General Account isn't offsetting the squeeze on liquidity coming from QT.
And the outflows are only accelerating, the note found, with half of the $150 billion liquidity drain occurring over the past three days.
"Investors have generally forgotten this story, because there wasn't an immediate negative reaction to the equity market," Dan Clifton, head of policy research at Strategas, told Insider. "I think there's a chance here for a surprise."
He said that a major liquidity drain could reverse the outperformance of long-duration stocks, such as technology and communication companies, while those focused on building things could see improved performance.
"To me, it's a really big financial market event," Clifton said.
Draining liquidity from the system could also lead to more bank failures, he warned, adding that he expects that risk will eventually pressure the Fed to slow down its quantitative tightening.
Money will continue to get sucked out of financial markets. Strategas estimated that the Fed's QT alone will drain $200 billion of liquidity by the end of August.
"It is likely that the drain will be larger than outlined because at least some of the Treasury issuance will come from bank reserves rather than the Reverse Repos. This is in addition to the QT effects," the note said.
Meanwhile, the Treasury Department is expected go on a big debt spree, and Strategas expects 50% of the issuance will come from bank reserves, which reduces liquidity.
Analysts at Deutsche Bank estimated in a note earlier this month that $1.3 trillion in T-bills will be issued over the remainder of 2023, bringing the total for the full year to about $1.6 trillion.
From June to August alone, Deutsche Bank predicted that cumulative issuance over the three-month period could top out at $800 billion.
