Since people keep saying things like “The Fed is injecting billions of dollars into this market and that’s why everything is going up” I want to argue real quickly why this is illiterate nonsense. 1/
The most important thing to understand is that “liquidity” isn’t a thing, so much as it is a condition, or characteristic of a given market. /2
I'm sure academics will complain about my definition. But basically liquidity measures the ease or speed with which one can trade at the fair price of an asset. /3
So for example, if $MSFT trades at $185, and you want to sell your shares, you'll almost certainly be able to get around $185 each, because the market for big cap equities is highly liquid. /4
On the other hand, take the market for real estate. Say you have a condo worth $500,000. That market is much less liquid than stocks, so it might take you weeks or months to achieve that price if you want to sell it, even if the market is healthy. /5
And let's say you have some highly customized, 15- bedroom condo that you think is worth $25 million. That market is even less liquid, so it might take you months or years to get your price. Rare real estate, art, classic, cars, etc all less liquid. All more difficult to sell /6
So right off the , you should be skeptical that liquidity is some thing that can be “injected” or measured by some simple line on a chart. /7
So what’s the Fed done? Due to regulatory requirements on banks, it’s gone into the market and exchanged short-dated government bonds for reserves held at the Fed. The key thing is, government bonds are basically the most liquid asset on earth. Even more liquid that stocks. /8
Now if the Fed were going out into the market and saying “we’re going to buy anyone’s condo at whatever the prevailing rate is on an immediate basis” then this would be changing the liquidity profile of a major asset. Because it would go from taking ~90 days to sell to 1. /9
And such change to the liquidity profile of real estate would be worth a lot, because being able to sell your condo that quickly would probably make you more willing to pay more for it in the first place, secure in the knowledge you could liquidate it for cash ASAP. /10
But again, that’s not what’s going on. Instead the Fed is swapping one extremely liquid asset (government bonds) for another extremely liquid asset (reserves held at the Fed) And the overall liquidity profile of private sector assets is virtually unchanged as a result. /11
So that’s it. There’s no “injection” of liquidity (it’s almost always a nonsense concept). And no previously illiquid asset has become liquid. There’s no basis for ascribing the market rally to this action.
