Here’s why the Treasury’s record-breaking borrowing won’t dampen Wall Street’s mood, says JP Morgan


Could the U.S.’s fiscal deficits drain liquidity from Wall Street as the Federal Reserve puts the brakes on its bond-buying and investors are forced to absorb the trillions of debt sold by the Treasury this year?

For analysts at JP Morgan, the answer is no.

In a note penned Friday, JP Morgan’s quantitative and derivatives strategy team argue the supply and demand imbalance for government bonds have little to do with liquidity — the potential pool of money that can be injected into the economy.

“By themselves higher government deficits or bond supply do not create or subtract liquidity, as they shift cash from bond investors to bond issuers which is then spent by the government to support the economy as income to consumers and businesses,” they said,

Some have looked at the potential mismatch between the Federal Reserve’s bond buying, as the pace of its operations taper off, and the Treasury Department’s record-breaking issuance this year as a sign that the U.S. central bank’s actions, on net, may not add liquidity to the financial system.

The Congressional Budget Office forecasts the U.S. to run a budget deficit of almost $4 trillion this year, while JP Morgan estimates the Fed will buy $4.2 trillion of assets this year.

See: Fed’s balance sheet tops $7 trillion, shows increased buying of corporate bond ETFs

This line of questioning takes issues with the widely held belief that the Fed’s push to boost credit has restarted the corporate bond market and was partly responsible for the S&P 500 index’s
SPX,
+1.96%

recovery from its March lows. The broad-based benchmark is up around 34% from March 23, this year’s nadir.

But JP Morgan argued central bank quantitative easing still increases the supply of money circulating in the financial system by boosting bank reserves.

Still, the growing need to save by households, businesses and investors may mean much of this liquidity will be withheld. The uncertainty around the COVID-19 pandemic’s impact has frozen industrial and consumer activity as individuals curtail spending across all sectors of the U.S. economy.

Yet for JP Morgan, this only adds fuel to their bullish thesis that the upbeat sentiment in Wall Street and rally in asset prices has further room to run.

“As the need for precautionary savings subsides over time this liquidity force would become more intense as more of the extra cash that was previously injected would start circulating in search for yield, chasing non-cash assets such as equities and bonds,” they said.



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