The Treasury's $1 trillion debt tsunami isn't as scary for stocks as Wall Street thinks, Deutsche Bank says

• Markets are misguided in worrying over the Treasury's massive debt issuance, Deutsche Bank said.
• Money market funds and foreign central banks will absorb a big chunk of the T-bills coming this year.
• That will minimize the impact on Fed liquidity, which doesn't affect stocks as much as Wall Street thinks, analysts said.

Expectations that the Treasury Department plans to rapidly issue a torrent of new debt have shaken the confidence of investors, who fear it may take liquidity away from stocks.

But analysts at Deutsche Bank wrote on Monday that the estimated $1.3 trillion in T-bills that will be sold between now and the end of the year will have less of an effect on liquidity from the Federal Reserve. They also said Fed liquidity is not as impactful on stocks as Wall Street thinks.

"We expect a substantial portion of the net issuance to be absorbed by money market funds and foreign central banks as they shift their holdings out of Fed repo programs to avail of the more attractive t-bill yields, reducing the impact on the popular measure of Fed liquidity, the Fed's balance sheet adjusted for the size of the reverse repo and the TGA balances," Deutsche Bank said.

Analysts added that the notion that stocks are considerably reliant on the Fed's liquidity hasn't held up in recent years.

Instead, fundamentals such as corporate earnings and macroeconomic growth are the reasons for the rally in equities since the Great Financial Crisis and the last three years, they said.

The correlation between Fed liquidity and stocks has appeared strong recently, but is very inconsistent going back further, suggesting it is "spurious," the note said. 

"Indeed, almost all the gains in the S&P 500 since the GFC are tied 1:1 with a rise in earnings," the analysts wrote. "Only a small portion of the gains have been driven by changes in the equity multiple, which are in turn also easily explained by fundamental drivers such as payout ratios and inflation, with a tiny role then left for liquidity, if any."

Meanwhile, the relationship between equities and macro growth has been strong and long-standing. Likewise, liquidity also seems to be correlated with growth, the analysts found.

"However, given that monetary policy changes famously impact growth with a lag, it is very unlikely that Fed liquidity is driving growth instantaneously," they said. "The causality in our view likely runs the other way, with growth driving endogenous demand for liquidity, and simultaneously also equities." 

Deutsche Bank estimated in a separate note last week that the Treasury will issue $1.6 trillion in T-bills over the course of 2023. That follows the suspension of the debt limit, allowing the department to replenish its depleted cash coffers.