Tyndall Monthly Commentary:Looking beyond the fiscal cliff

At present, financial markets seem to be enjoying a little “run” that has been based on rumours of an impending Chinese economic recovery and better liquidity trends within the US.  At present, the former factor really is only “rumour”; some of China’s more recent economic data has looked a little better but the data is patchy and not always that accurate.  We can, though, be more definitive over US liquidity trends, which have begun to look quite robust despite what seems to have been a marked failure of Bernanke’s latest QEP to gain traction.  In fact, the cause of the latest surge in US liquidity has not been the Federal Reserve but the Federal Government itself.

It seems that the Treasury Department has been running an extremely large budget deficit over recent months (this is largely for seasonal and storm-related reasons) but what is unusual is that it has been funding this deficit not by issuing the equivalent amount of new Treasury Bonds to investors (which implicitly takes money out of the financial system) but instead by running down its own cash reserves.  In a sense, the Treasury has been opening up its piggy bank and then using the money to fund the deficit, thereby moving the cash out of the government’s bank vaults, where they were sitting idle, and giving them to the real sector through the deficit and implicitly therefore to the financial sector.  This factor, together with the maturing of some bank debt securities, has been sufficient to provoke the US money supply into one of its more robust periods of expansion for some time and this liquidity will support risk markets until the year end and perhaps even beyond (assuming that the political side of the Euro Crisis does not erupt again in the meantime).