Last week the modifiers held while the core stayed flat. I wrote that the system was coasting, not driving, and asked whether we were seeing healthy normalization or the early stages of something less pleasant.

This week we got an answer. Sort of.

The regime hasn’t changed. We’re still Neutral/Chop, still stuck in the center of the matrix with minimal conviction. Policy and Risk Appetite are both holding at +1, providing the tailwind. But underneath the surface, something interesting is happening. Net liquidity drained $86 billion in a single week. The TGA swelled by $90 billion. BTC is tracking lower, aligned with the drain. And the divergence tracker (the one that flags when stocks and liquidity stop agreeing) is flashing BEARISH SHORT SIGNAL.

Yet the signal validation system says the rally is high quality. Four checks pass. Credit is calm. Vol structure is healthy. Breadth is adequate.

One of these is lying. The question is which one.

Current Regime: Neutral/Chop | Aggregate Score: +2 | Conviction: Minimal

The modifier pillars are holding. Policy and Risk Appetite both stable at +1, that’s providing the tailwind that keeps us in the constructive part of Neutral/Chop rather than sliding toward Late Cycle. Growth and Inflation at zero, Liquidity at zero. The core regime is directionless, but the modifiers are doing their job.

The dashboard says 50% probability we stay here. That leaves 50% we don’t. And given what the liquidity numbers are doing, I’m watching closely whether those modifier scores can hold.

Growth holds at 0.

Not new news but something worth flagging; ISM Services New Orders minus Inventories is sitting at +3.7. That’s the Services spread (New Orders 57.9 − Inventories 54.2). When new orders outpace inventories in services, it signals strengthening demand and building backlogs. That’s forward revenue.

Everything else? Largely unchanged from Issue #007:

•          ISM Services: 54.4 (unchanged)

•          NFP 3-month average: 52k (down from 59k—softening continues)

•          GDPNow: 5.4% (was 5.3%)

•          Divergence check: Aligned — Soft Landing (unchanged)

The services-labor tension from Issue #006 persists. Services strong, labor soft. That divergence hasn’t resolved but the New Orders suggests it might resolve to the upside rather than down.

Growth Score: 0 (Neutral) | Trend: ↑ | Divergence: Aligned (Soft Landing)

The downstream narrative from Issue #007 holds. But upstream is heating up.

Pipeline update:

CRB commodities +3.4%. Baltic Dry +12.4%. That’s upstream pressure building. Tariffs showing up in input costs. The question is whether it transmits downstream.

So far, it hasn’t. Tariff pass-through monitor: Upstream +8.24% → Midstream +3.30% → Downstream -0.41%. Core CPI still falling YoY. But if upstream keeps rising while midstream expectations stay anchored, something has to give eventually.

The “Pipeline Clearing” flag remains active because downstream is still decelerating. But the upstream acceleration is worth flagging, this is the early warning of where tariff pressure shows up first.

Inflation Score: 0 (Stable) | Trend: ↓ | Pipeline: Clearing (upstream heating)

Policy still at +1. Last week’s cooling reversed.

The framework logic from Issue #007 still applies: Fed on hold, fiscal stimulative, financial conditions loose. What changed is the composite score recovered. The “deceleration” I flagged last week didn’t persist.

Key readings:

Financial conditions at -0.59 are the loosest we’ve seen. The “Both Loose = Bubble Risk” flag from last week remains active. Nothing new there, just confirming the setup exists.

Policy Score: 1 (Neutral) | Trend: ↑ | Mix: Both Loose

This is the story of the week. Net liquidity drained $86 billion in seven days.

Source: Federal Reserve H.4.1 Release (federalreserve.gov/releases/h41)

Last week I wrote that net liquidity was rising (+$27B) while the RRP buffer was nearly exhausted. This week, the TGA swelled by $90B (Treasury building cash) and that drained reserves from the system. The RRP, already at $3.3B, dropped to $2.1B. Effectively zero cushion.

For context on why the RRP exhaustion matters, see Issue #007. Short version: any funding squeeze now hits bank reserves directly.

The divergence that matters: BTC at $89,578, down from $93,636. Bitcoin tends to lead net liquidity by ~2 weeks. When BTC falls while SPX holds flat, something has to give.

The divergence tracker says it plainly: SPX vs Net Liq = BEARISH SHORT SIGNAL.

Good news: plumbing normalized. SOFR-repo collapsed from 10 bps to 2 bps. MOVE index down to 56 from 67. The acute stress isn’t there, but the structural drain continues.

Liquidity Score: 0 (Neutral) | Trend: ↓ | Divergence: BEARISH SHORT SIGNAL

Risk Appetite back to +1. Signal validation unchanged from Issue #007: 4/4 PASS, HIGH QUALITY.

Credit tighter. Vol calm. The validation system says this rally is real.

The tension: Breadth is weakening underneath. S&P >50 DMA dropped to 66.2%. NYSE >200 DMA fell to 64.1%. A/D line diverging from SPX continues. Prices holding while participation fades, that’s the same pattern the liquidity divergence is showing.

Copper/gold at 0.00119, still flashing fear (was 0.00127). That divergence from Issue #006 hasn’t resolved.

Risk Appetite Score: 1 (Risk-On) | Trend: ↑ | Rally Quality: HIGH (4/4) | Breadth: Weakening

China improved. Score back to +2 from +1. All three global risk flags now clear.

The slowdown flag that was active in Issue #007? Cleared. FXI rising. Copper showing expansion signal. Caixin back above 50.

Global Risk Flags: 0 of 3 Active

USD/JPY improved, down from 159 after the BoJ held rates and struck a neutral tone Friday. Still deep in intervention territory, but the immediate pressure eased. No hawkish surprise, no intervention. For now.

Carry unwind mechanics and intervention risk covered in Issue #007.

Alert Status: 🔴 MULTIPLE TRIGGERS — Full Regime Review

The divergence tracker says SHORT. The signal validation says SIZE UP. Both can’t be right.

Here’s the tension laid out plainly:

The bear case (divergence tracker): Net liquidity drained $86B in one week and BTC is falling, aligned with the drain. SPX is holding flat while the liquidity tide goes out. Historical pattern: when SPX diverges from net liq, SPX ends up catching up. (Q4 2018, Feb 2020, Late 2021, divergences resolved to the downside).

The bull case (signal validation): Credit isn’t worried (HY at 264 bps, tightening). Vol structure healthy (contango, VIX at 16). Trends strong (SPY, QQQ, IWM all 3.5 ribbon scores). China improving (+2 score). ISM Services New Orders - Inventories positive (+3.7, first time in months).

The caution: Breadth is weakening underneath the strong trends. Participation down 5-7 points WoW. The momentum overlay confirms what the liquidity tracker is saying: surface calm, undercurrents shifting.

I don’t have a clean answer yet. The data is genuinely contradictory. Liquidity says risk-off. Credit says risk-on. Growth indicators improving. Policy and Risk Appetite modifiers holding at +1.

My best read: the divergence is real, but timing is uncertain. Net liq divergences have historically taken time to resolve. We’re early in the process. The signal validation passing suggests this isn’t imminent, but it’s also not nothing.

What I’m watching:

•          TGA trajectory: If Treasury keeps building cash, the drain continues. Watch for drawdowns below $800B as a potential relief valve.

•          BTC: If it breaks below $85k while SPX holds, the divergence intensifies. If BTC stabilizes, maybe the drain is priced.

•          Credit spreads: HY at 264 is the truth serum. If this starts widening toward 300+, the divergence is resolving to the downside. Currently: calm.

Regime: Neutral/Chop. Aggregate: +2. Conviction: Minimal.

Framework logic by asset class covered in Issue #007. Quick updates on what’s changed:

Large Caps: Trends strong but breadth weakening underneath with participation down. The divergence between price strength and internal weakness is the tension to watch.

Small Caps: Rate sensitivity typically a tailwind in this environment. If breadth keeps fading, small caps tend to feel it first.

Duration: Pipeline clearing is duration-positive. Growth stable limits the rally case, but momentum is turning. Worth watching.

Credit: HY at 264, tighter. Truth serum passing. If you believe signal validation, credit is fine. If you believe the divergence, credit is next to crack.

Gold: Signpost triggered. Central bank bid intact. Extended but trending.

Copper: Expansion signal from China, but copper/gold still flashing fear. The ratio and price are disagreeing, historically, the ratio tends to lead.

DXY: 97.46, below the 100 signpost trigger. Dollar weakness persists, down from 99.38 last week. Rate differential compression (Fed cut, others held) continues to weigh.

USD/JPY: 155.71. Tail risk persists. BoJ held and struck neutral tone, but intervention risk remains at these levels.

Growth confirms boom: ISM Services > 55, NFP > 100k, copper/gold ratio turns. → Reflation.

Growth cracks: ISM Services < 50, NFP < 50k, Real Income negative. → Late Cycle.

Inflation reaccelerates: Core PCE 3M > 3.5%, Supercore reverses upward. → Stagflation risk.

USD/JPY reverses: BoJ intervention, moves < 152. → Carry unwind cascades.

Credit cracks: HY > 400 bps. Currently 264, along way off, but that’s the line.

Divergence resolves: Either SPX catches up with net liq (bearish), or net liq stabilizes and BTC recovers (bullish). One of these happens in the next 2-8 weeks.

Regime: Neutral/Chop | Aggregate Score: +2 | Conviction: Minimal

The modifier pillars are holding. Policy and Risk Appetite both stable at +1, that’s keeping us in constructive territory. Growth and Inflation at zero, Liquidity at zero. The core regime is directionless, but the modifiers are doing their job.

That’s the framework output.

The divergence is the story. Net liquidity drained $86B in a week. BTC is tracking lower. SPX is holding flat. Breadth is weakening and participation is down 5-7 points. The divergence tracker says SHORT. But the signal validation says the rally is HIGH QUALITY; credit calm, vol healthy, trends intact.

Both signals have good track records. Both can’t be right. My read: the divergence is real but not imminent. Timing divergences is notoriously difficult. Q4 2018 took weeks to resolve. Feb 2020 was more swift.

The signposts remain triggered. USD/JPY at 155.71 (eased post-BoJ), DXY below 100, Gold above $300. The carry unwind risk hasn’t gone away, it’s just been patient.

TGA swelling. The plumbing is functioning, but the structural drain continues.

The framework points to patience. The modifiers are holding, the divergence is building, but nothing has broken yet. The divergence will resolve, one way or another.

The data will tell us. It always does.

See you next Sunday.

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