The Dollar: The Market’s Biggest Addiction
System Addict: How Liquidity Shapes the Market's Future (Systems on the bottom)
Liquidity is the lifeblood of financial markets, understand it, and you’ll understand where the market is heading.
Liquidity drives markets upward and fuels momentum. It’s what allows dips to get bought, breakouts to trend higher, and multiple asset classes to move in harmony. Liquidity determines how easily assets can be bought or sold without causing significant price changes. For traders, abundant liquidity is key, it makes entering and exiting positions smoother and more efficient.
When liquidity dries up, everything changes.
Markets become choppy, spreads widen, and volatility spikes. Whether it’s the Fed tightening liquidity through rate hikes or flooding the system with cash during economic slowdowns, liquidity drives how markets function.
Traders know the golden rule… follow the liquidity, and you’ll often find where the market is heading next.
Liquidity Indicators: What's Happening?
Domestic Liquidity: Staying flat for now. This will likely continue until the $200B left in the reverse repo facility is used up. Liquidity levels are low compared to the past few years.
Banks: 2024 is different from 2022 and 2023.
Small banks are gaining more liquidity now, reversing the trend from when big banks were absorbing more during rate hikes.
Since the spring 2023 regional bank crisis, overall bank liquidity has been steady or improving slightly.
What’s Next: Expect liquidity to stay steady in the coming months, unless there’s a major global event.
Global Liquidity: The Dollar’s Role
The Dollar Index (DXY) has surged since the election. This rise makes it harder for global liquidity to grow because many debts and trade contracts are in dollars.
However, steady liquidity will put pressure on the dollar. Inflation is rising slowly in the United States but it is rising much faster all over the world.
The Point: Global rates will have to stop moving lower before the Federal Reserve. This will put pressure on the dollar. It is a race to the bottom.
Daily candlestick chart of the US Dollar.
Weekly candlestick chart of the US Dollar.
Post-Election Policies: Uncertainty (An Objective View)
After elections, there’s often a gap between promises and what actually happens. This time, the gap might be even bigger.
The key issue:
Tariffs: New tariffs could shake up trade, but their size and impact are unclear.
Tariffs will undeniably increase the cost of goods and services, impacting U.S. liquidity in two phases: adding liquidity (inflation) initially but tightening it later. It’s unclear whether these tariffs are merely a negotiation tactic or will be implemented, we’ll have to wait and see.
A new advisory group called the Department of Government Efficiency (DOGE) has ambitious goals:
Led by Elon Musk and Vivek Ramaswamy.
Aim: Cut up to 75% of federal jobs and reduce deficits by $2 trillion by 2026.
Challenges:
Jobs: Cutting 1 million federal jobs saves about $110–$150B per year. But taxes and benefits reduce the real savings.
Defense Spending: The Department of Defense is a big target, but it’s deeply tied to politics and hard to cut.
Social Programs: Most spending (Medicare, Social Security, interest payments) is untouchable, leaving limited areas to cut.
Takeaway:
Unrealistic Goals: Cutting 75% of federal jobs or saving $2 trillion seems unlikely because of political and structural hurdles.
What This Means for Traders: Big deficits will probably stick around. For now, focus on stocks, gold, Bitcoin, and short-term investments, and avoid long-term bonds.
The Dollar: The idea that a strong dollar is tied to the president's actions is misguided. The value of the dollar isn’t controlled by the president—it’s shaped by the global economy.