Liquidity Drains and Yield Spreads Put S&P 500 at a Crossroads
Stocks had a volatile session, broadly finishing lower. The sharp morning sell-off was unexpected, though the rebound was not. The real test comes tomorrow with $44 billion in Treasury settlements and the reverse repo facility now depleted, which could trigger a repeat of yesterday’s poor performance.
The TGA climbed yesterday to $563 billion, up from about $520 billion the day before. If tomorrow brings another decline like we saw in the NASDAQ, it will likely reflect the impact of Treasury settlements and the depletion of the repo facility.
For now, the S&P 500 is holding support at the uptrend. Even if that breaks, the key level to watch is 6,200. A break there could send us back into the 5,900s, and that’s when concerns would grow.
The spread between the US 5-year and the 5-year JGB continues to decline, now barely holding above its lowest level since August 2022. Once the 2.65% spread breaks, there is little in the way of support, aside from minor levels at 2.37% and 2.10%. The strongest support sits at 1.94%.
With the spread narrowing, dollar demand is weakening, as seen in the 5-year USDJPY cross-currency basis swap, which has become less negative at –13.5 bps. The trade appears to be swapping out of dollars and back into yen, as the cost of obtaining yen has eased. This suggests new carry trades are unlikely to be initiated, and if the spread continues to move toward zero, the risk of an unwind in existing carry trades will increase.
In essence, this isn’t just a US dollar issue—it’s happening elsewhere too, such as in the MXNJPY. More interestingly, this FX pair has recently been trading in step with the S&P 500. We saw this dynamic in the summer of 2024, and it has been tracking the index fairly closely again for some time.
This relationship becomes clearer when viewed in the context of the fall of last year. More importantly, if the MXNJPY is topping out, a break lower would likely coincide with—or reflect—a broader risk-off move, given how closely the pair has been trading with the S&P 500.
-Mike
Terms By ChatGPT
Defined Terms and Jargon
Treasury Settlements: The process where buyers of newly issued U.S. Treasury securities transfer funds to the Treasury in exchange for the securities, temporarily draining liquidity from the financial system.
Reverse Repo Facility (RRP): A Federal Reserve tool that allows money market funds and other institutions to lend cash overnight to the Fed in exchange for Treasury securities; its depletion suggests reduced excess liquidity.
TGA (Treasury General Account): The U.S. Treasury’s operating account at the Federal Reserve, used for managing government cash flows such as tax receipts and debt issuance.
US 5-year vs. JGB 5-year Spread: The yield difference between U.S. 5-year Treasury bonds and Japanese 5-year government bonds (JGBs), which influences currency flows and carry trade activity.
Cross-Currency Basis Swap: A financial derivative used to exchange payments in different currencies; a negative basis indicates higher demand for one currency over another.
Carry Trade: A strategy where investors borrow in a low-yielding currency (e.g., yen) to invest in a higher-yielding currency or asset, profiting from the interest rate differential.
Risk-Off Move: A market environment where investors reduce exposure to risky assets, often selling equities and high-yield currencies in favor of safer assets.
MXNJPY: The exchange rate between the Mexican peso (MXN) and Japanese yen (JPY), often used as a proxy for global risk appetite given its sensitivity to emerging-market and yield-driven flows.
This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.