American SICO - 1. Market impact
2 min read

American SICO - 1. Market impact

American SICO - 1. Market impact

The US stock market appears to experience a full-blown Stimulus-Indigestion-and-Crowding-Out (SICO) episode right now.

SICO is a simplified theory of mine to explain the correlation between risk asset prices and Feb balance sheet size, as well as the size of the bank reserve (anti-correlated).

For Fed actions:

Type Impact
QE UST mildly bullish
QE MBS mildly bullish
QT MBS mildly bearish

For Treasury actions:

Type Impact
UST auction mildly bearish
UST settlement no impact
spending < 8Bn/day bullish
spending > 20Bn/day bearish
tax bullish

The main assumption here is that a couple of major banks have balance sheet sizes fairly close to their SLR limits. Sudden (1-day) influx of large reserve causes their broker/dealer arm to freeze or even withdraw margins of their clients (e.g. hedge funds). And it takes a few days for these big banks to shed the extra reserve on their balance sheets to other players (e.g. MMF, foreign banks etc.).

Charting the equity indices against these liquidity flows, the correlation appears to quite good (>90% if we add Fannie & Freddie to the equation).

In the next couple of posts, we will examine the underlying transmission mechanisms (hypothetic), why is it happening now, and what roles Fannie and Freddie are playing. Stay tuned.

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