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Deutsche Bank: The $1 Trillion Treasury Debt Wave Isn’t the Market Menace It Appears to Be

In a market where investor confidence can hinge on a single tweet or press release, the Treasury Department’s expected issuance of a staggering $1.3 trillion in Treasury bills (T-bills) by year’s end might seem like cause for concern. But financial experts at Deutsche Bank are here to allay your fears.

The worry? This huge wave of new debt could siphon liquidity away from stocks, affecting their performance. The good news, according to the Deutsche Bank analysis, is that the effect on Federal Reserve liquidity, and therefore on stocks, may not be as drastic as Wall Street prognosticators predict.

Deutsche Bank experts anticipate that a significant portion of this net issuance will be snapped up by money market funds and foreign central banks. This would happen as these entities shift their holdings from Fed repo programs to take advantage of more attractive T-bill yields. This shift would then reduce the impact on the widely-watched measure of Fed liquidity.

The widely-accepted theory that stock performance hinges heavily on the Fed’s liquidity isn’t as robust as it seems, the analysts argue. They suggest that the critical drivers of the equity rally since the Great Financial Crisis, and over the last three years, have actually been fundamentals like corporate earnings and macroeconomic growth.

At first glance, the correlation between Fed liquidity and stocks seems strong in the short term. But a more comprehensive review reveals inconsistency, which suggests that this correlation could be merely coincidental.

The Deutsche Bank report stresses that nearly all gains in the S&P 500 since the GFC align 1:1 with an increase in earnings. The small portion of gains driven by changes in the equity multiple can also be linked to fundamental drivers like payout ratios and inflation, leaving a minuscule role for liquidity, if any at all.

Interestingly, the connection between equities and macro growth is long-standing and solid. However, Deutsche Bank analysts argue that while liquidity appears correlated with growth, it doesn’t necessarily drive growth. Noting the lag between changes in monetary policy and their impact on growth, they believe growth actually drives demand for liquidity, and by extension, equities.

In a recent note, Deutsche Bank estimated that the Treasury will issue $1.6 trillion in T-bills over 2023. This follows the suspension of the debt limit, allowing the Treasury to restore its depleted cash reserves.

So for those investors unnerved by the imminent trillion-dollar debt wave, Deutsche Bank’s perspective offers a comforting alternative viewpoint. It seems the market monster may not be as scary as it first appears.