Did Liquidity Drive the Sell-Off?

ZH: Liquidity Tsunami Foiled: Why This Has Major Implications For Markets

This matters, because as we and repo guru Zoltan Pozsar explained (here and here), this massive flood of liquidity entering the market would trigger a multi-faceted domino effect across assets, potentially pushing funding rates (FRA-OIS, repo, etc) negative, even as the glut of "safe collateral" hit demand for longer-duration, resulting in curve steepening and higher yields in longer-dated paper. And since the market is now extremely sensitive to any yield increases - reflationary or otherwise - a paradox emerged: despite over $1 trillion in liquidity hitting the market, the impact on risk assets would be largely negative.

That said, all of this however was predicated on one thing: that the Treasury's funding needs would remain unchanged for the quarter (and beyond), which also implied that no further stimulus would pass during the first calendar quarter, and that the Treasury's cash balance target would remain $800BN at Mar 31, all else equal.

But that it no longer the case: as of this weekend, Joe Biden's $1.9 trillion - technically $1.8 trillion - stimulus plan passed the Senate and it's now just a matter of fine tuning it in the House before it is signed into law. Said otherwise, it is now just a matter of day before the Treasury's funding needs change dramatically, and the Treasury's borrowing forecast as of Feb 1 is no longer applicable.

This has huge consequences for the market, which first was slow to adapt to the initial liquidity tsunami scenario and is now just as slow to realize that it has now been foiled.

...And since there will no longer be a flood of liquidity that dealers will have to absorb, it also means that there will be far more capacity for regular coupon securities. In short: a flattening of the curve is imminent, as are lower 10Y yields... and by extension higher stock prices as this move will likely be viewed (incorrectly) by algos and quants as a disinflationary trade.