The Stock Market May Face Another Liquidity Test as Treasury Borrowing Surges

Stocks fell again on November 2, despite the S&P 500 rallying by as much as 1% earlier in the session. By the end of the day, all of those gains had been erased, with the index finishing down around 25 basis points. Volatility also rose sharply following the morning crush, which saw the VIX 1-day fall from Friday’s close of 19.3 to 10.6 at the open, only to rebound to around 18 by the close.

It’s difficult to say exactly what drove today’s price action, with the midterm elections tomorrow, a calendar packed with economic data, and earnings season still underway. However, what stands out is the continued decline in the SPY-to-RSP ratio, as weakness in semiconductors and technology continues to weigh on the headline index.

The big news today, I guess, was that the Treasury Department now expects the Treasury General Account (TGA) to finish the year at $850 billion before rising to $1 trillion by the end of March. The Treasury expects to borrow $800 billion in the January-to-March quarter. I don’t know how it plans to break down that borrowing, but wow, that could mean a lot of T-bill issuance if coupon auction sizes aren’t increased. That’s a significant jump from the $574 billion in borrowing during the same quarter a year ago.

Given the relationship we’ve observed over the past year, the projected increase in Treasury borrowing and the TGA balance could create additional headwinds for market liquidity.

Meanwhile, the 2-year Treasury yield was essentially flat on the day, even as oil prices plunged. The 2-year yield still appears to be forming a bullish flag pattern, suggesting yields could move higher. It just can’t seem to break out.

It is worth mentioning that the 10-year Treasury yield fell today, while the 10-year real yield rose. That means inflation expectations declined by more than nominal yields, causing the 10-year breakeven inflation rate to narrow. This could be an important development worth monitoring, particularly if the divergence continues.

-Mike

Michael Kramer publishes independent macro and options research read across 10+ platforms and by institutional desks.

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Glossary by ChatGPT

Breakeven Inflation Rate: The difference between nominal Treasury yields and comparable-maturity TIPS yields, representing the market’s inflation compensation over that period.

Bullish Flag Pattern: A technical chart formation characterized by a sharp upward move followed by consolidation, potentially signaling continuation of the prior uptrend.

Coupon Auction: A Treasury auction involving interest-bearing securities, such as Treasury notes and bonds, that make periodic coupon payments.

Implied Volatility: The level of expected future price fluctuations embedded in option prices.

Market Liquidity: The availability of cash and funding that facilitates transactions across financial markets without significantly affecting asset prices.

Real Yield: The inflation-adjusted yield on a bond, commonly measured using Treasury Inflation-Protected Securities.

SPY-to-RSP Ratio: The relative performance of the capitalization-weighted S&P 500 ETF (SPY) versus the equal-weight S&P 500 ETF (RSP), reflecting differences in performance between larger index constituents and the broader index.

T-bill Issuance: The sale of short-term U.S. Treasury securities with maturities of one year or less to finance government obligations.

Treasury General Account (TGA): The U.S. Treasury’s primary operating cash account at the Federal Reserve, used to receive government revenues and make payments.

VIX 1-Day (VIX1D): The Cboe index measuring the market’s expectation of S&P 500 volatility over approximately the next trading day, derived from short-dated SPX options.

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