Market Signals Point to Shift in Liquidity and Leverage

The ISM manufacturing index is expected to come in at 48.2, slightly below last month’s 48.4, but the prices paid index is forecasted to rise to 51.4 from 50.3. Leveraged futures contracts haven’t shown signs of recovery, suggesting a lack of demand. For instance, the March contracts finished Tuesday at 74.5, sharply lower than prior highs near 180. This suggests leverage demand has normalized from previously stressed levels.

Whether this is an end-of-year balance sheet adjustment remains to be seen, and we’ll have a clearer picture during the first two weeks of trading, especially after the jobs report on January 10. Yesterday, the reverse repo facility saw a significant jump to $473 billion, up nearly $200 billion from the prior day. This facility, which once held over $2.5 trillion daily, had declined to near-zero levels by December 20. The rise is surprising, as the expectation was for it to continue draining liquidity and head toward zero. Most of this liquidity has shifted into Treasury bills, an effective way to soak up excess liquidity. With a new administration coming in, there’s speculation about shifts in debt issuance strategy, potentially moving from T-bills to longer-duration bonds (5, 7, 10, or even 30 years). Such a shift could push long-term rates higher. Currently, the Federal Reserve’s rate-cutting cycle appears to be nearing its end, with market pricing suggesting minimal likelihood of multiple cuts this year. With neutral rates estimated at 3.5%, adding 300 basis points points to a potential 6–6.5% for the 10-year yield. Liquidity draining from the reverse repo facility and shifting into longer-duration assets may reduce leverage in the market. Significant U.S. debt rollovers expected this year could also create further liquidity challenges. On the equity side, Tuesday’s NYSE new highs minus new lows were negative 41. The cumulative trend in this metric is starting to roll over, which can signal underlying market weakness

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