The Liquidity Conundrum
by: Christian O’Neal
Despite the Fed’s QT engine and recently announced tapering, liquidity in the system has remained strong. How is that possible? Under normalized circumstances, quantitative tightening reduces the money supply, and sucks liquidity out of the system as maturing treasuries roll off the Feds balance sheet. When the Fed sells treasuries, bank reserves typically decrease resulting in lower liquidity, directly impacting domestic capital flows. This cycle, however, the Fed has created liquidity backstops behind the scenes, keeping liquidity high and stimulating the system as the private sector (money markets) have been absorbing treasury issuance that would otherwise be absorbed by banks, thereby preserving and increasing liquidity (bank reserves).
If capital can lock in 5%+ yields for 12-18 months, they will continue to do so at it is a great risk adjusted opportunity relative to investing in risk-on vehicles that have not presented asymmetric bets relative to inherently safer ones. The market demands a premium over their quantification of inflation, or risk-free rates. But what happens when the risk-free nature of the system is at question altogether? The US government won’t default on its debt anytime soon, but at the same time, history has taught us that the US is on an unsustainable fiscal path, and eventually other sovereign nations will ditch a currency that prints away its value. In the near term, we may see increased spreads as investors demand additional risk premiums until we reach a greater consensus about the future of policy, growth, and security.
Partner with us to navigate the complexities of commercial real estate. Get in touch today to explore how our expertise can unlock the full potential of your real estate investments.