I can not emphasize enough how important this distinction is, as it relates to the markets. Liquidity Policy isEVERYTHINGto The Street.EVERYTHING. If they can't borrow at cheap or next to nothing overnight rates, they can't trade profitably on ANYTHING. They do this through the Repo Market, and by putting up US Treasuries, TBills in particular, for margin, sometimes borrowing up to 99.9% of face value. Do that with say a JPMorgan bond, and they'll lend you 75% of face value. The higher the risk bond, the less margin value.
Back to the story of "How It Works, And Why It's Important"::
Quantitative Tightening did not begin this month. It began one year ago. Let me explain…
The Federal Reserve has two tools to implement its monetary policy, one old and one new.
The old tool is interest rate policy. The Fed uses short-term interest rates to encourage or discourage credit creation and money supply.
The new tool is liquidity policy. To save the financial system in 2008, the Fed directly intervened in the US Treasury (“UST”) and Mortgage-Backed Security (“MBS”) markets to stabilize prices and inject much needed liquidity into an over-levered banking sector. The original QE was a wartime measure - the first large scale use of liquidity as a policy tool - but wartime measures have a way of sticking around.
With interest rate policy, the Fed conducts an orchestra, guiding the musicians with its baton. With liquidity policy, the Fed grabs an oboe and plays it with a leaf blower.
[Two very important points left out.
The TBills deposited at the MMFs and other FSIs must remain unencumbered (not use for margining purposes, anywhere in the system.).
The Street can't use these to trade any more. So, because of the Corzine Rule*, any little loss, anywhere, requires selling something else to cover that margin call. (Look at the spasms in Crude Oil (WTI) if you don't believe this "Rule" exists.).
*Corzine Rule = "There shall be no excess margin in the system, at any time." (Corzine was trading, for the house, using customers' Excess Margin (unrealized Profits). Statute of Limitations for this crime ran out on Oct. 31, 2016. Thanks, Holder!)