Slowing credit expansion, triple liquidity headwinds: who is pulling the ladder out from under asset prices?

Author: Benjamin Ussache (@Corsica267)

TechFlow Guide: The market is generally fixated on macroeconomic confidence indicators such as GDP, non-farm payrolls, and current-period output growth, yet often overlooks that the underlying logic of asset prices has never been about absolute scale, but rather marginal financing conditions and the slope of credit expansion.

As the Federal Reserve’s H.8 report reveals a cliff-like drop in bank credit growth from 7.7% in Q1 to 3.3% in September, and as major Wall Street banks admit in earnings calls that they are constrained by the SLR requirement, making lending in Q4 increasingly picky and cautious, the cost of “rolling over debt” to maintain existing positions within the financial system has quietly risen.

Coexisting with diverging real-economy fundamentals are three hidden shocks: the Treasury’s issuance of short-term bonds crowding out bank reserve cash, global liquidity drain caused by weak USD rebounds, and the widening spread between US Treasuries and high-yield corporate bonds.

The prosperity of asset prices relies on a continuously extended ladder of leverage, and when slowing credit growth resonates with liquidity tightening, even if leading companies' earnings do not show deterioration, denominator-side repricing will inevitably severely damage cash equivalents and risk assets.

Credit Growth

In my view, the macroeconomic analysis framework centered on output and income growth has a notable flaw: many economic activities capable of altering financial conditions and asset prices are not directly reflected as current-period incremental output.

For instance, the sale and purchase of secondary housing.

I purchase a second-hand house from you using a bank loan plus my own principal. Money changes hands, the property is delivered, new deposits and loans are created, and the balance sheets of both parties and the bank change, with credit likely increasing as well. However, aside from transaction services like brokerage and legal fees, the mere transfer of the property itself does not count toward current GDP because it does not add to goods or services produced in the current period. While this accounting method naturally makes sense, the fact that a transaction isn't counted as incremental output does not mean it is irrelevant to economic operations and financial markets.

The same principle applies to financial asset trading.

Although transactions are not included in the statistics, that doesn't stop us from asking questions. After this transaction concludes, where did the funds go? Has credit increased? If the seller uses the proceeds from the house sale to pay off existing bank loans, the credit expansion brought by the buyer's new loan will be partially or completely offset; if the seller uses the proceeds for consumption or continues to buy assets, it will form different expenditures and transactions. In short, the buying and selling of financial assets usually does not directly increase GDP, but may be accompanied by changes in leverage, collateral, and financing demand. Merely observing output growth cannot fully reveal what changes are happening on these balance sheets, nor can it determine whether the financing conditions supporting asset prices are improving or deteriorating.

To some extent, in many cases, the reason we are unwilling to judge the market solely based on GDP or output growth is precisely that these indicators fail to adequately reflect changes in financing conditions, which is especially true for investors participating in risk asset markets. Asset prices trade future expectations, which are first constrained by current financing costs, credit availability, and risk tolerance. In other words, even if economic data shows no obvious deterioration, asset markets may still face pressure due to slowing credit expansion and rising financing costs. Beyond analyzing the fundamentals of a company or industry, we must also ask at what speed credit is expanding, which sectors it flows into, and whether the financial system still has the capacity and willingness to support new financing and the continuation of existing positions.

To put it more bluntly: the economy can grow, demand can be robust, and productivity can improve, but these conditions do not guarantee that asset prices will necessarily rise. If marginal buyers need to borrow money to purchase, and existing holders need to constantly roll over debt to maintain their positions, then the availability of financing and the affordability of its cost will directly impact their ability to buy and hold. An asset, even if still bullish, may lack buyers because they cannot secure loans, or face sell-offs because holders cannot refinance.

We can draw a parallel to a contradiction during the gold standard era. Demand for production and trade could continue to grow, but because the market needed to maintain gold convertibility requirements, and the increased supply of gold couldn't keep up, it ultimately forced the financial system to tighten credit. Unable to meet financing needs under the original conditions, factors like bank capital, financing costs, collateral conditions, and policy direction all affect the elasticity of credit supply. Thus, trades that clearly have demand might not go through, and assets still viewed favorably might not be held onto; originally optimistic expectations for growth might simply not withstand the immediate pressure of needing to finance and repay debts.

The above writing is too formal and a bit stiff.

The Fed's H.8 report on "Assets and Liabilities of Commercial Banks in the United States" updates commercial bank credit growth weekly. Of course, commercial bank credit growth cannot be directly equated with that of the entire US financial system, as it includes subcategories like bank credit and loans and leases, but it remains broadly instructive. The version released on October 16, 2026, shows bank credit growing at 7.7% in Q1, 6.6% in Q2, 5.3% in Q3, and 3.3% in September, reflecting a downward trend. Among these, securities holdings grew at 4.4%, 3.1%, and 3.5% respectively, dropping to -6.2% by September, while commercial and industrial loans saw a slight recovery in September after a sluggish third quarter.

The above data can serve as evidence that bank credit expansion has begun to slow, but whether this slowdown is causing financing pressures in the asset market is uncertain, because the market can fill financing gaps outside of banks. To some extent, constrained bank supply is one possibility for slowing credit growth, while declining borrowing demand would yield the same result. The latter, however, is worse, because if companies cancel expansion plans, reduce inventory, and cut hiring due to falling orders, profit expectations, or investment returns, then slowing credit growth becomes a signal of weakening real-economy activity.

We must fully realize that bank balance sheet expansion, or an increase in credit, has never represented merely a single asset or liability.

Then comes the second leg.

Concentrated bank earnings reports.

In Goldman Sachs' earnings call Q&A, someone specifically asked about the SLR, questioning whether Goldman's current capital expectations can handle Q4 business volume. SLR, widely discussed earlier this year regarding the deregulation of banks, was supposedly done to allow banks and institutions to hold more Treasuries, especially long-dated ones. We've already seen the results now; long-dated Treasuries plummeted so much in the past few months that they became unrecognizable. Perhaps we can infer that deregulating bank capital actually pushed banks to more readily accept corporate bonds and institutional businesses, allowing them to dump a batch of lagging long-dated bonds to further expand their balance sheets and invest in the most valuable businesses.

Back to the main point. Goldman stated in its response that Q4 funding levels give them confidence to complete business for institutional and key clients, with overall leverage and total asset levels expected to remain roughly unchanged from Q3, adjusting primarily around the SLR. They also noted that the fastest expansion occurred in January and February, and it will be difficult to see such growth rates in the coming months. Cross-referencing earnings reports confirms this: Q1 saw the fastest growth, Q2 peaked in expansion, and Q3 slowed down.

JPMorgan provided a similar response, stating that lending and project support in Q4 will become more cautious and selective.

The incremental seem to have come down as well. Or rather, what's more troublesome is that even if increments don't drop, choices on the balance sheet are becoming more cautious.

This is precisely why I always emphasize the slope and the growth rate. Absolute amounts and scales are meaningless. For GDP, inflation, and credit expansion, what matters is the speed represented by the slope, not the absolute values.

If we synthesize and compare the above judgments, some inferences still cannot be entirely confirmed. For example, will this supply volume broadly impact prices? Unknown, since many companies can secure financing outside of banks or through specific banking programs. Will lending standards tighten or will loan demand weaken, and will these changes affect fundamentals? It holds little value investigating this, as market divergence has been glaringly apparent for a very long time, and the real economy is simply weak. We still lack sufficient evidence to conclude that funding issues are genuinely impacting the fundamentals of your tech stocks. Certainly, funding concerns are gaining attention, such as recently discussed corporate bond spreads and institutions starting to offload projects to retail investors. I won't offer overly subjective judgments here; I have my own strategies, for instance, I only short NQ in futures, never go long. But here we will only discuss what is more certain.

What is more certain?

Liquidity shocks.

Three-Fold Headwinds to Liquidity

When prices dropped again in early October, I heard bond market commentators say it resembled early August 2025. Truly said.

Slowing credit growth confirms that institutions are more cautious and selective regarding projects and leveraged exposures, but this does not mean balance sheets cannot grow. Banks could absolutely expand leverage alongside capital without changing the SLR ratio. There is just one constraint here. If banks are unwilling to lower capital buffers, and capital growth itself is insufficient to support financing demand, then new business must compete for limited balance sheet space. In other words, one must constantly sell off old items to constantly bring in new ones. This constitutes the first layer of potential liquidity headwind, or in my own words, balance sheet crowding-out.

So, is there a scenario that forces institutions to frequently adjust their balance sheets?

Yes, government bonds.

Currently, two relatively consensus expectations have formed regarding the Treasury's new quarterly financing guidance for November. First is adjusting the debt issuance structure: issuing more short-term bonds and fewer long-term bonds to further push down long-end yields. Market chatter certainly mocks Bessent bringing up Yellen's past, but in reality, the Treasury already did this once last summer. Go long on market makers and institutions, short cash equivalents, go long on cash rolling short-term bonds, swinging according to the Treasury's settlement dates. Second is the possible suspension of 20-year auctions.

Stepping aside briefly here. My longstanding view remains: if the Treasury wants to adjust the duration structure, it should issue more 7- to 10-year bonds and fewer short-end and ultra-long-end bonds. Also, although people constantly mock the small total repo limits of the Treasury and the Fed, proportionally speaking, it's actually quite substantial. The side effect here stems from the Treasury issuing quite a lot extra debt to secure repo funding quotas; if the goal is to reduce borrowing volumes, halting repos and suspending 20-year auctions are equally effective. Whether they will employ both tactics simultaneously depends on articles I shared previously; specifics await the new guidance. We'll discuss debt issues later.

A somewhat superficial view holds that issuing more short-term bonds is bullish, as it eases long-end pressure on one hand and provides high-quality collateral to the market, effectively releasing liquidity. But regardless of historical records, the Fed's own research papers, or the summer we experienced last year, the conclusion points to the same thing: short-term bonds crowd out cash and accelerate the drawdown of reserves, frequently triggering liquidity events when reserve quotas are low. Institutions need to absorb bonds, and once issued, they must be held. Long-bond crowding-out on balance sheets lies in interest rate volatility, hence the subsequent decline after settlement; short-bond crowding-out lies in how cash usage impacts repurchases, hence larger drops before settlement and on the day itself. If the Treasury indeed adjusts its issuance structure again, increasing the total volume and frequency of short bonds, we will witness more frequent liquidity fire sales. Cash equivalents like precious metals will fall first, followed by overseas national assets dropping along with it, causing a second plunge in precious metals, which then transmits to dollar-denominated assets beginning to fall, resulting in a third drop in precious metals.

The second headwind.

And then the third headwind: the US dollar.

Old habits die hard; I've circled back extensively just as we begin discussing macroeconomics.

Recent Asset Performance

After the end of the Bretton Woods system, many economists questioned why the dollar still had the capacity to maintain its status as the international reserve currency. Minsky's explanation was that the Fed has the ability to proactively create dollar scarcity. This is certainly just his perspective, but his explanation for inflation is highly interesting: excessive issuance of long-term bonds is equivalent to borrowing future-generated currency for use today, lowering both current currency value and future investment returns, thereby raising required yields while diluting purchasing power. Pondering this angle is fascinating.

Back to the dollar.

By traditional understanding, the dollar should currently be in a strong position. Energy price volatility, a potential upward trend in commodities, a possible European debt crisis, geopolitical conflicts, and the concentrated sale of overseas assets to repatriate dollar cash amid liquidity shocks are all theoretical bases for keeping the dollar strong. We have indeed witnessed the impact of these factors; the dollar peaked in mid-October, and then... the momentum vanished.

The reasons are relatively complex. The strong dollar has indeed been maintained to some extent, and the US naturally hopes to preserve this strength to counteract import prices, nominal growth, and Treasury purchases. But this intensity truly falls short. Using the simplest analytical method, the dollar only has four destinations: USD cash, US Treasuries, US equities, and gold. Since gold and US equities are falling and the dollar isn't strong enough, capital can only flow into Treasuries. We have indeed seen Treasury yields decline. Ultimately, this boils down to lowered expectations for US rate hikes, risk-averse buying, and a bearish outlook on dollar assets (without distinguishing long vs. short term). Bond market yields cannot rise infinitely under free-market conditions; at a certain level, capital will always be willing to buy in, and a significant portion of exchange rates derives from interest rate differential expectations. Structurally over the long term, we judge the euro will remain relatively weak, while the yen will comparatively strengthen.

Naturally, this brings us back to US Treasuries.

At the end of Q1, my article's concerns focused on whether future nominal growth could outpace inflation. After a fiery Q2, Q1 kicked off with a major shock, falling for three consecutive months, with overseas markets especially volatile as they faced liquidity drains. At that time, I began narrowing my focus to monitor the expansion or contraction of the current account or trade deficit, i.e., the balance between nominal growth and debt growth speeds. Now, entering Q4, the focus has shifted to the balance between credit expansion speed and debt growth speed. Essentially, both observe intertemporal mismatches between commitments for future cash flows and current cash payable, just from different angles. This is what is referred to as cash management and cash commitment.

Let's look at it from another angle.

Up to now, has AI Capex spending significantly decreased? No, even if so, it's limited. Meanwhile, has the Treasury's debt issuance amount significantly decreased? Impossible to see. Especially knowing we're facing a government prone to disruptions, and economic fundamentals are gradually becoming fragile; everyone expects debt issues to worsen. Relying on a little effort from Congress is like pouring water onto a burning cart—insignificant. Under the superposition of these two factors, total debt isn't decreasing, nor is its growth slowing. After we shorted for a month in June, market news outlets finally began concentrating their discussions on: Supply Monster.

There is an issue of Hierarchy of Credit here, namely the credibility of the issuer.

When capital is relatively abundant, the market can bear higher interest rates, and optimism prevails for future markets, high-return projects are favored. The primary concern for lent funds then revolves around when costs can be recouped and how many entities can succeed. Broad market rallies occur, led by blue chips, where growth valuations outweigh corporate cash flows. In such an environment, seeing excessive Treasury issuance and oversupply, the market wouldn't doubt whether Treasuries will default; it's simply deemed unworthy. Now, however, when funding sources, capital costs, and overall returns face scrutiny, default risk suddenly becomes the paramount issue, and US Treasuries are the hardest to default on. Thus, corporate bonds become less attractive, and spreads widen. Does widening spreads mean companies can't rally anymore? No. Does it mean sector or industry fundamentals are broken? Also no. But more issues signify higher risk premiums, prompting capital to adjust positions. With the denominator raised, even if the numerator remains unchanged, prices must fall.

Furthermore, what is the nature of the borrowing? Take US Treasuries, for example, which technically cannot repay the principal, let alone the interest. Some companies roll debt by issuing new bonds to cover old interest payments. And for the enterprises currently in focus, they mainly borrow only for new bonds, expecting revenues to cover both principal and interest. The market is making risk adjustments due to default concerns, but it isn't entirely reclassifying the nature of the assets.

Therefore, it all circles back to the issue of credit growth. Many rebuttals on the macro front claim consumption is fine, nominal growth is fine, employment is fine, prices merely erode income, and macro fundamentals remain solid. But none of this answers the question pointed out at the very beginning of this article: Has credit been effectively expanded? Are companies daring to borrow for expansion? Is the market daring to borrow to buy homes? Are banks daring to loosen lending? Do commercial banks' balance sheets have room? Does the Fed have a chance to significantly expand its balance sheet? And finally, even if it expands, cuts rates, and boosts liquidity, is new credit used to offset old credit, or applied to investment and consumption? What about your inflation?

This is why we lock the issue onto credit growth. From a first-layer perspective, it's a neutral rate problem. The market faces two ROI tiers: the lower and upper legs of the K-curve. Correspondingly for the Fed, it's two neutral rates. Rate cuts direct more funds to AI companies, while rate hikes pull more capital away from the real economy. From a second-layer perspective, it's a problem of monetary transmission channels, which current tools cannot effectively resolve. As I shared before, the Fed anticipated this situation internally in 2019 and proposed solutions, albeit requiring massive action. If that massive action cannot be taken, we move to the third layer: credit growth. If growth accelerates fast enough to entice the market to reinvest capital, divergence will widen further—the strong get stronger, the weak get weaker, from markets to nations. Alternatively, the Fed releases credit, whether acting preemptively or cleaning up the mess afterward. One certainty is that a batch of overseas countries will inevitably blow up regardless.

Thus, mentioning overseas countries inevitably brings up France and European debt. From the divergence of Franco-German sovereign bonds, we see the benefit to US Treasuries and the diffusion of European debt. I've actually written about this before; everyone review 2011. The ultimate trend hinges on whether Europe or the US cuts rates first. While China and Japan dump US Treasuries, Europe gradually begins buying them starting in August.

In summary, my approach to bonds is to overweight a batch of 2-to-5-year maturities, locked around 5%. On one hand, to capture risk-aversion trades, on the other, to ride the rate cuts due in two years. Additionally, I locked in a batch of 5-year maturities yielding 9.2% through products. It's entirely duration-driven. I haven't touched long bonds much; if things go south, long bonds will still crash hard, so I'll enter then.

Finally, there are always those asking about gold. Amid liquidity shocks, gold faces suppression from the three aforementioned headwinds. Short cash equivalents. Even setting aside the first and third layers, the second layer alone causes highly erratic price action. Why am I so certain it's a liquidity shock? Because when US Treasury yields decline, the dollar ceases its accelerated surge, yet gold still distinctly leads equity indices in a decline, that signals a liquidity shock. Gold's smooth and sustained rally can only achieve massive gains when the market feels inflation and debt spirals are beyond control—two skepticism drivers toward central banks—meaning when monetary credit and purchasing power falter. That hasn't arrived yet.

Exhausted. Let's leave it here. Haven't written long-form articles in ages; stamina is gone.

Sincerely,

Benjamin Ussache