It’s funny how things turn out, but prior to Powell’s speech we had a conversation about the following graph planned for last night with Andrew Hunt. To some extent it felt like events had overtaken that conversation, but on closer examination we are convinced that the two conversations are very much interlinked.

In this week’s video Andrew outlines how central banking activities have expanded as ‘needed’ over the past few decades and we ask the question of whether the Reverse Repo Facility is another such tool (don’t worry none of us apart from Andrew really knew what Quantitative Easing was in 2008 or even 2009 either!) If you don’t have time to watch the video here is the summary:

• Powell's more dovish stance in recent Fed meetings has surprised many. He acknowledges there are uncertainties in forecasting and is trying to avoid financial market accidents, especially given fragile areas like repo markets.

• The massive money creation during COVID led to issues absorbing it all, so the Fed set up the reverse repo facility as a "reservoir" for excess liquidity. Releasing this is like a "backdoor QE" that offsets quantitative tightening.

• Recently the Treasury has been issuing more T-bills and fewer bonds, replacing expiring bonds with bills. This releases liquidity from the reverse repo facility into markets, helping fund deficits.

• This liquidity wave has boosted asset prices over the past month or two. But the reverse repo reservoir is finite, so this source of liquidity relief will likely run out around Easter.

• Powell seems concerned about uncertainties and unintended consequences from liquidity moves. The Fed and Treasury may not have initially realized the macro power of tools like reverse repos and may have exploited it recently.

• The liquidity wave may get markets through year-end fragilities, but it's unclear what tools remain if more support is needed in 2023. The Fed will likely have to get creative with new mechanisms for adding liquidity.

The punch line? Yes, it does look like that sharp fall in the line on the right-hand side of the bottom panel in the graph above is why markets went up last year and possibly why the US economy and financial system have proved so surprisingly robust despite rising real interest rates. It is essentially an aftershock from the extraordinary fiscal and monetary COVID stimulus and represents about $1.5 trillion dollars re-entering the economy via the US treasury. The sharp rise to over $2 trillion represents cash accumulating in a liquidity dam and the sharp fall last year is most of out being let back (or being drawn) back into the real ecopomomy. That would just about do it. It also largely explains why the gains were focused in some areas of the market – we have heard that about 70% of US hedge fund equity exposure is concentrated in the ‘Magnificent 7’.

Even more intriguingly there was a moment at the end of Chairman Powell’s Q&A on Thursday where he is belatedly asked about the Fed’s balance sheet and, having been flawlessly engaging and ‘on message’ for 42 minutes, he starts to fumble, and then reads from something in front of him. OK, so we are having a bit of fun with this and it might sound a bit conspiratorial but if you like geeking out on this stuff we suggest you go to 44 minutes and 30 seconds in this video (Chair Powell’s speech). Once you see it you can’t unsee it. Then maybe watch our weekly video with Andrew. For those of you that have a life, rest assured that we are watching this space very carefully on your behalf.