What We See: Financial Trends & Economic Indicators
What We See: Financial Trends & Economic Indicators
Understanding Financial Conditions, Reverse Repo Dynamics, and Economic Leading Indicators
Newsletter Rundown:
Easy financial conditions
Reverse Repo stays level
Strong ECRI Weekly Leading Index
Final Word
It’s not about the money – it’s about the system. We continue to be optimistic for investors because the system is healthy.
We believe that easy financial conditions and positive net liquidity are both showing signs which are positive for risk assets.
Easy Financial Conditions
Frequent readers should know I like using the Adjusted National Financial Conditions Index.
The Adjusted National Financial Conditions Index (ANFCI) is a comprehensive weekly update on 105 U.S. financial conditions across three categories of financial indicators (risk, credit, and leverage).
We prefer this measure due to its adjustments for inflation.
The weekly data goes back to the 1970’s, includes “shadow banking” metrics, and is a key input in our investment outlook.
Positive values have historically been associated with tighter-than-average financial conditions. (Bad for risk assets)
Negative values have historically been associated with looser-than-average financial conditions. (Good for risk assets)
We are currently in a favorable loose condition which is positive for risk assets.
When you look closer into the biggest contributors , such as credit conditions, the majority are positive. For example, credit spreads are back to lows not since 2019.
Our research indicates that for risk assets to selloff, ANFCI will need to meaningfully tighten under scare liquidity. Source
Reverse Repo Stays Level
Since last year, we have seen a sustained and methodical release of funds from reverse repo, serving as an intraday relief valve for liquidity into the financial system.
When you reduce RRP, you now have treasuries free and clear of the overnight sweep.
Banks get to extend duration by purchasing treasuries which are able to be used as collateral to take risk beyond one day.
The free treasuries can be leveraged into risk assets and held for longer terms in money market fund deposits.
Since the introduction of the bank term funding program, we have looked at reverse repo to measure general net liquidity conditions.
This month, the drawdown pace slowed significantly compared to previous months.
See grey line in the chart above.
It appears there has been a leveling off around in the range of $430B - $500B.
This leveling off suggests that reverse repo will not be drawn down to zero by April as we previously assumed.
We believe this could mean two things:
The Federal Reserve is confident in favorable financial conditions and is willing to maintain slightly tighter liquidity as a result. Powell understands the importance of reverse repo in daily market activity. We believe its possible that Powell wants to preserve the final $500B to be held back to be prepared if/when an unexpected market event arises.
The Treasury General Account (TGA) is now in focus. The TGA becomes the next release valve in measuring net intraday liquidity. This is the most logical reason, given the percent makeup of liabilities on the balance sheet.
In a simple comparison, if you compare the Federal Reserve Balance Sheet from seven months ago to today, the most notable changes have been:
The drawdown in liabilities of Reverse Repo (26% to 12%)
The increase in liabilities of TGA (5% to 10%).
When you look at this balance sheet simplified, it helps put things into perspective and demonstrates the limited options the Federal Reserve has to decrease it balance sheet.
When you decrease assets, liabilities are generally decreased as well.
We expect the next significant move to be made in the TGA account and that is our focus for net liquidity if the reverse repo remains stable.
Based on our research, we may see a potential level of the TGA around 5-7% and reverse repo steady around 10% of total liabilities.
This would increase net liquidity by another $200B - $400B without the drawdown of reverse repo to zero.
This is positive for the market generally.
Strong ECRI Weekly Leading Index
The Economic Cycle Research Institute (ECRI) maintains a proprietary composite of leading economic indicators. It has an impressive record, going back decades, of signaling recessions and business cycle changes. Source
I like to use the Weekly Leading Index (WLI) as a high-frequency leading index of U.S. economic growth.
The latest ECRI Weekly Leading Index indicates a increase in growth, returning back up near an impressive peak of 9% in February.
Historically, this has been a good indicator of when recessionary pressures are in the rearview mirror.
The substantial rebound since mid-November and sustained rates above 7% indicate a strong upward trajectory, suggesting likely continued growth.
We consider this a positive sign for equity markets going forward.
Final Word
Thank you for reading and I am grateful and humbled to be able to learn, grow, and invest alongside you at Tuttle Ventures.
Vision, courage, and patience leads to successful investing.
Don’t forget to follow Tuttle Ventures on Twitter, LinkedIn, or Instagram.
Check out the website or some other work here.
Best,
Darin Tuttle, CFA
This is not investment advice. Do your own due diligence. Past performance is no guarantee of future results. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Investors are encouraged to perform due diligence, consider their risk tolerance, investment goals, and consult with financial advisors before making investment decisions. I make no representation, warranty or undertaking, express or implied, as to the accuracy, reliability, completeness, or reasonableness of the information contained in this report. Any assumptions, opinions and estimates expressed in this report constitute my judgment as of the date thereof and is subject to change without notice. Any projections contained in the report are based on a number of assumptions as to market conditions. There is no guarantee that projected outcomes will be achieved.
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