Arthur Hayes's Liquidity Index comparing to SPX, NDX & BTCUSD liquidity conditions are comprised of three parts:
The size of the Fed’s balance sheet.
FRED:WALCL The Fed credits member banks’ Fed accounts with money, and in return, banks sell the Fed US Treasuries and/or US Mortgage-Backed Securities. This is how the Fed “prints” money to juice the financial system.
The size of Reverse Repo (RRP) balances held at the NY Fed. FRED:RRPONTSYD The NY Fed allows eligible counterparties to deposit USD and earn a rate of return. The deposited funds become dead money once they enter the Fed’s account. It is dead money because the Fed does not use the deposited funds to make commercial loans. If it did, it would increase the supply of credit money in the financial system. In effect, the money multiplier for RRP balances at the NY Fed is 0x, vs. a non-zero multiple when deposited with any other financial intermediary. (Pre-pandemic, the reserve ratio requirement hovered between 3% to 10% – resulting in a 33x to 10x money multiplier for US commercial banks – but the Fed has since slashed it to 0%, meaning that commercial banks can lend out 100% of the deposits they receive with no obligations to hold any of those deposits as a safety net). Money market funds (MMF) are funds in which retail and institutions place cash to earn short-term yield. In my brokerage account, any spare cash I have is deposited in an MMF, and I can get my cash back within one business day. MMFs can deposit funds in the RRP, and a variety of other low-risk short-term credit instruments (e.g. US Treasury bonds, AAA-rated US corporate commercial paper). Leaving money with the Fed is the least risky option, and pays about the same as the other two options, which do carry some risk. Therefore, MMFs prefer to park money with the Fed, if they can, rather than in the leveraged financial economy.
The US Treasury General Account (TGA) balances with the NY Fed. FRED:WTREGEN This is the US Treasury’s checking account. When it decreases, it means the US Treasury is injecting money into the economy directly and creating activity. When it increases, it means the US Treasury is saving money and not stimulating economic activity. The TGA also increases when the Treasury sells bonds. This action removes liquidity from the market as buyers must pay for their bonds with dollars.
USD Liquidity Conditions Index = (The Fed’s Balance Sheet) – (NY Fed Total Amount of Accepted Reverse Repo Bids) – (US Treasury General Account Balance Held at NY Fed)
