At the end of March, the Fed reinstated the required reserves into the SLR of the banks. In order to avoid problems with the banks’ ability to maintain their ratio requirements, the Fed opened the overnight reverse repurchase facility where banks could funnel excess reserves into T-bills and earn interest — the Fed swaps T-securities for cash (takes in cash and puts out T-securities). This is the opposite of QE. This is tightening; reducing liquidity.

However, because the Fed is continuing with the SOMA expansion, the net tightening is somewhat blunted. Subscribers are well aware of the fact that the SPX rises as long as the SOMA is expanding, so it is no surprise that since the ON rev repo started blunting the SOMA expansion, the SPX has stopped rising (chart below).

Coronavirus relief payments added $131B during the month of May:

This was all absorbed by the ON rev repo. The Fed is doing this to keep the banks healthy while reserves are flowing into savings instead of into the working economy.

The effect on the stock market, of sequestering funds in savings, is also visible in the chart of institutional money market funds (chart below).

As the economy opens up and the infrastructure spending stimulates the economy even further, we expect that the reserves sitting in deposits will come out and be invested in the real economy…and the stock market will rally higher.