Author: Tiezhu Ge in CRYPTO
At the beginning of the year, invited by Talk Jun, I had a discussion with @TJ_Research, @qinbafrank, and @viviennaBTC about the macroeconomic situation for the coming year. It was very enjoyable and enlightening.
Taking this opportunity, I would like to share a more comprehensive view on the macroeconomic outlook for next year.
This is a series that includes U.S. dollar liquidity, U.S. Treasury bonds, and the dollar, intertwined with views on monetary and fiscal policy. Due to space limitations, many of the contents cannot be elaborated on. The analysis of liquidity, U.S. Treasury bonds, and the dollar is a vast financial project. I have understood some superficial aspects and hope to provide some insights.
1. A Deeper Understanding of U.S. Dollar Liquidity: The Impact of the Federal Reserve and G-SIBs on Dollar Liquidity
In an article at the beginning of 2025, I systematically explored how the Federal Reserve's balance sheet affects U.S. dollar liquidity (see link at the end of the article). However, in today's market, where fiscal policy gradually dominates, simply analyzing the Federal Reserve is far from sufficient.
From a balance sheet perspective, U.S. dollar liquidity is not merely the numerical value of the Fed's balance sheet. It should be defined as the willingness and ability of financial intermediaries (especially G-SIB banks) to expand their balance sheets under the current risk appetite.
The entire financial system is essentially a nested structure of balance sheets, where each layer represents the repayment commitments of the previous layer. Although the Fed's role as a lender of last resort remains important, in practice, dollars do not flow directly from the Federal Reserve to the market. They must be transformed into tradable, leveraged financial liquidity in the financial market through the balance sheets of large banks, influenced by regulatory constraints and capital requirements.
In other words, the perceived and actual availability of dollar liquidity in the financial market depends not only on the Fed but also on whether banks, as intermediaries, are willing to release these dollars and at what cost.
This issue becomes particularly critical when we realize that the reserves in the banking system have fallen to a level that seems still ample but is no longer marginally loose.
The market's response to dollar liquidity is highly asymmetric: in other words, a slight easing does not elicit a significant market reaction; however, once it tightens, the impact can be very destructive. Therefore, in 2026, this situation is likely to persist for some time, making the analysis of bank balance sheets crucial from the perspective of dollar liquidity.
2. Dissecting Dollar Liquidity: Nominal Liquidity and Usable Liquidity
A well-known formula for measuring total U.S. dollar liquidity is: Fed balance sheet total - TGA (Treasury General Account) - overnight reverse repos (RRP). This formula worked well before 2025 because bank reserves were excessive, and balance sheets did not constrain the dollar's intermediary capacity. In other words, nominal liquidity was roughly equivalent to actual usability.
Entering the second half of 2025, the market's dollar liquidity has essentially shifted from quantity constraints to intermediary constraints. Simply put, banks' ability to intermediate dollars has been greatly restricted. This is akin to the relationship between water level and water pressure.
Globally, G-SIBs (Globally Systemically Important Banks) are fundamentally constrained by a series of regulatory standards set by the BIS (Bank for International Settlements).
After 2010, the main regulatory framework was the new Basel III agreement. This agreement, in essence, aims to curb banks' scale impulses through various regulatory indicators. The core indicators introduced leverage ratio (SLR) and liquidity coverage (LCR/NSFR) requirements, particularly targeting important banks, increasing their capital requirements and comprehensive risk coverage.
Thus, under these regulatory requirements, banks' business orientation must consider how much capital will be consumed and whether it will affect the achievement of regulatory indicators.
The definition of SLR is simple: Tier 1 capital / all on-balance and off-balance sheet assets (government bonds, loans, derivatives, etc.). Generally, this ratio is 3%, but for large banks (those with over $250 billion in size), the ratio is 5%. Under this formula, holding U.S. Treasury bonds and making loans have no difference in capital consumption.
As a result, the guiding outcome is that at certain critical points, under capital consumption constraints, banks will inevitably choose high ROI businesses; low-yield government bond market-making and repos will decrease.
The key analysis here is the government bond repo (Repo) market. The main participants in the Repo market are represented by MMFs, banks, and hedge funds. The role of banks is to act as market makers. Therefore, at the end of the quarter, to meet regulatory indicators, when hedge funds borrow money from banks using government bonds as collateral, the collateralized U.S. Treasury bonds must enter the bank's balance sheet and consume Tier 1 capital.
Once banks' capital consumption or balance sheet space is limited, as the lender of funds, banks will either stop lending or significantly raise interest rates.
The result is that some hedge funds, in order to survive (e.g., margin calls), may have to liquidate U.S. Treasury bonds at any cost. At this point, you will see a surge in U.S. Treasury yields, accompanied by a spike in SOFR rates.
Another very important factor is the RLAP requirement (intraday liquidity regulation). Regulators require that at any moment during a trading day, there must be sufficient, readily available high-quality liquidity to respond to extreme scenarios of capital outflow.
Therefore, even though you can see that bank reserves are not low, a portion of them is locked up. In other words, banks tend to maintain more ample reserves. This will also exert influence at quarter-end and other critical times.
3. How to Analyze the Tightness of Dollar Liquidity
Before further discussing the monitoring indicators of dollar liquidity, there is another key variable that needs to be clarified: the pressure of offshore dollars.
From the operational mechanism of the global dollar system, dollars do not circulate only within the U.S. On the contrary, a large amount of dollar credit is created, rolled over, and leveraged outside the U.S. This offshore dollar system heavily relies on foreign exchange swaps (FX Swap) and cross-currency financing to borrow dollars.
Non-U.S. banks do not have a base of dollar deposits and will use FX Swaps to convert local currency liabilities into dollar liabilities. Therefore, objectively speaking, it reacts more quickly to changes in liquidity than onshore dollars.
Thus, we can roughly derive a simple analytical framework for analyzing dollar liquidity: offshore financing costs - onshore repo pressure - bank balance sheet behavior - asset price response.
1) Offshore dollars: cross-currency basis (core: USD/JPY basis / EUR/USD basis), which expresses the borrowing cost for banks to access dollars in the offshore market; and FX Swap points, where the former being more negative and the latter being larger generally indicates that offshore financing pressure is rising.
2) Onshore dollars: the core analysis focuses on the Repo market, mainly looking at the deviation levels of SOFR and IORB, combined with the MOVE index. If SOFR continues to be above the policy level, it indicates that banks are unwilling to lend funds. Of course, for a more in-depth analysis, one can also pay attention to the performance of government bond auctions and repo market rates; significant volatility or increases would also indicate higher financing pressure.
3) Bank balance sheet behavior: for example, an increase in RRP not accompanied by an increase in Repo, or a rapid rise in SRF usage, etc.
In addition, the decline in liquidity's intermediary capacity can also lead to some other anomalies that are not typically seen, such as simultaneous declines in both stocks and bonds, which may not be due to inflation but rather due to tightening in the repo market. For instance, abnormal widening of credit spreads may occur, and even if economic data is good, liquidity may become tighter.
Recently, the market has been discussing the potential relaxation of SLR in the U.S. in 2026, which essentially means loosening the intermediary constraints on dollar liquidity, expanding balance sheet space, and avoiding sudden spikes in financing rates at critical points that could trigger a deleveraging chain reaction. At the same time, considering the current weakness of the dollar, the continuous expansion of the fiscal deficit, and the issues surrounding interest rate cuts and midterm elections, the foreseeable situations may include:
1) Poor digestion of U.S. Treasury bonds: even if interest rates are cut to around 3.0, the difficulty of a smooth decline in long-term yields remains significant, and even the tail of bond auctions may not look good, as the primary market's absorption capacity itself becomes the biggest constraint.
2) Changes in the TGA account will have a greater impact on the market. With RRP exhausted today, the TGA's influence on Repo rates may be greater than before.
3) Changes in the Repo market: a massive amount of debt encountering urgently needed leveraged funds may lead to greater volatility in the market at quarter-end and tax payment dates, while the liquidation of basis trades could become the biggest tail risk.
In the absence of SLR relaxation, loose monetary policy and tight credit will become the dominant scenario in the market for some time, with the asymmetry of risk being extremely prominent at the liquidity level. In a tight balance state, banks' willingness to expand their balance sheets is suppressed, making the analysis of stock-bond correlation less meaningful, and it becomes easier for both to collapse simultaneously, with the 64 combination failure potentially continuing.
For ordinary people, cash remains an important defensive tool; meanwhile, gold and commodities can serve as very effective hedging instruments. At the same time, when analyzing an asset, it is essential to pay attention to which segment of liquidity transmission it is in. For example, altcoins or low-liquidity assets can easily become exhausted and crash.
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