Stocks finished the day lower following the hotter CPI report. The S&P 500 was all over the place, though, trading with big swings. These swings seem to be a sign to me of a market that is becoming less liquid. We saw this a lot in 2022, especially as reserve balances held at the Fed fell.
Over the past few trading sessions, we have seen the size of the top of the book on the S&P 500 futures start to thin out. While it is not as thin as we saw in 2022, it caught my attention enough that I thought I should point it out now, especially since we know that the Bank Term Fund Program is now unwinding, and reserve balances are likely to head lower from their current levels.
The top of the book tells us how big the size of the bid or offer is, and when the size of that bid and offer diminishes, it can make the market move more than when the bid and offer have a large amount of size.
The red and green bars represent the depth of the book, the wider periods represent more depth, and the smaller values show less depth. The light blue line is the S&P 500. The chart clearly shows how the depth of the book gets wider when the index rises and thinner when the index falls.
The interesting thing here is that we know that the S&P 500 mainly trades with changes in liquidity and the amount of leverage out there and that the rising reserve balance since March of 2023 has helped lift margin levels and the S&P 500.
But if it is the case that reserve balances have peaked due to the end of the BTFP and the continued drain from QT, then it would also suggest that leverage should begin to diminish, and the changes we see in the book depth could be a reflection of that.
So, if book depth is declining, it may serve as the best real-time gauge for the direction reserves and margin levels are heading. This needs to be watched closely, especially over the next few weeks.
I don’t have much to add today because, in the end, the CPI report came hotter than expected, and inflation is proving to be much stickier than the market expected. Today, the S&P 500 moved into a more vulnerable spot, and at this point, it will need to break the 5,150 level to open up further downside risk.
If it is the case that liquidity is leaving, and if it is the case that inflation is going to remain elevated, and if it is the case that rates and the dollar will rise and that financial conditions will tighten, then the peak in the index could very likely already be in, and the move lower may have already started.