Title: The North Star vs. Liquidity — Revisiting Nash During the 'Ceasefire' Show: Paulo Macro (Substack) — paid Guest: Paulo Macro ("Cloudbear") Date: 2026-APR-11 URL: https://paulomacro.substack.com/p/the-north-star-vs-liquidity Length: written post (no timestamps) Note: Back-filled post (processed 2026-JUL-07). Byline reads APR 11, 2026 (raw file was named pm_2026-apr-12.txt; byline wins — folder is 2026-apr-11). With risk assets bouncing back to near-highs on a "ceasefire," Paulo articulates two concepts. (1) The "North Star" — a Nash-equilibrium read of the Iran conflict: Iran's optimal strategy (constrain Hormuz flows, inflict "Never Again" economic pain to force US midterm regime-change) does NOT change regardless of Trump's tweets/decisions, so the market's "TACO"/look-through reflex is a Misconception. Robert Pape's "Escalation Trap" backs into it. (2) Liquidity & Positioning — a primer on the three drivers of US liquidity (Fed RRP, TGA, bank reserves) explaining the late-quarter "Risk On": RRP drained to ~zero, TGA drawn down ~$300bn (Bessent holding issuance ahead of April 15 tax receipts), RMP injections lifting reserves; hedge funds dumped hedges at the fastest pace since May '25, positioning at the 27th percentile (room on the downside), Momentum L/S ripped to new highs. He flags the April 15 TGA rebuild removing the tailwind (a "Sell in May" set-up) and the strong "must-own tech" consensus, weighing the Broadening-Out-then-final-megacap-ramp path (1972/2000/2021) vs Kevin Muir's don't-own-Mag7 take. Macro/liquidity/positioning note — no individual equity tickers named (only generic Mag7/tech). Body reproduced for personal study; Substack chrome removed, wording otherwise verbatim.
The recent bounce in risk assets has all but unwound the decline in equities and credit since the Iran war began, confounding traders in the process while confirming the temptation among many to "look through" to an end of the war and its supply chain disruptions. When you start seeing charts like this everywhere, it's safe to say the proverbial "Wall of Worry" and grind higher is looking all but inevitable to most investors, and that once again the right thing to do was to just hang on or buy more.
Color me the proverbial wall of worry, but no this won't be an onslaught of bear porn. Actually I don't have a strong take for you or obvious trade. Rather, I want to articulate a concept I have been called the North Star as well as a subject I have not discussed in a long time, namely, liquidity. I'll wrap a positioning review in at the end.
The North Star
I need to address the North Star first because I started using it on chat and have fielded a ton of questions on what I was talking among newer readers. When the war broke out, I outlined my concern that despite investors' Pavlovian reflex to buy any dip (or monetize hedges quickly), the consensus rush to assume a "TACO" was bothering me. I began to use this meme:
For the first time in my life, I have been able to apply Game Theory at the highest geopolitical/macro level, and define sequencing and event-driven market outcomes directly. With the endless talk of 'TACO' (as if this mess is simple a function of Trump unwinding a decision), I finally wrote the following on the March 23rd chat opener (edited here for better legibility):
There is a subject called Game Theory which is pretty good for determining outcomes based on game player incentives. In Chapter 1 you learn about the Nash Equilibrium which defines how a single player's optimal strategy does not change no matter what the other players do, or how other players change their strategy or decisions. The moment the bombs started to fly on the Purim Blood Moon (which was one of two dates I had for the war to kick off — the other being the Iranian Revolution 47th anniversary in mid February), I became vocal about this.
Quite simply — and in another version of Shrub's Razor where the funniest, most absurd outcome is also the likeliest — Iran's optimal strategy for short- and long-term regime survival is to make the war so economically costly for the US and rest of the world that it would force "Never Again" (Pearl Harbor), and possibly even boomerang 'regime change' on the US. In other words, to ensure "never again," key commodities ranging from oil, gas, fertilizer, etc would be constrained and remain so. To accomplish that, the boats would stop moving. Months of skyrocketing oil product prices and basic input costs would destroy Trump's alliances abroad and popularity at home, resulting in a severe loss at the US midterms (regime change via the ballot box).
Importantly: this strategy **does not change** no matter how many tweets Trump may drop. Those furious behind-the-scenes conversations? It's Turkey, no Pakistan, no it's the Qataris. It doesn't matter. There is no central chain of political command to speak with until the 40-day mourning period for the Ayatollah is up on April 9th anyway (conveniently the date of the next UST 30y bond auction), and since the IRGC is running the show, this is all a moot point. Iran's strategy is the only thing that matters. And just as I said as far back as January that there was practically no doubt in my mind there would be war (you don't mobilize assets to this degree and not use them outside of total capitulation), the fact that the USS Tripoli and 31st Marine Expeditionary Force are set to arrive in the next few days with at least two other battalion groups enroute tells me the path here remains escalatory and boots on the ground are highly likely.
My guiding light — my North Star — is to see this conflict through the lens of Nash. Iran's strategy does not change. Trump takes his ball, goes home, and tells Europe and China to deal with the Straits? Nothing changes…shipments remain constrained. Sure maybe Iran will let some boats through in exchange for tribute and foreign goodwill, but nowhere near enough to keep global oil/chemicals/fertilizer balances from drawing, and prices will go higher until the US feels enough pain that we get to "Never Again." Trump puts boots on the ground? Nothing changes, same logic. It's lose/lose.
Imagine my pleasant surprise when professor Robert Pape, author of Bombing to Win and Dying to Win, gave an outstanding interview two weeks ago where he laid out his Escalation Trap that just happens to back into my North Star perfectly (this is long but a must listen). For years, he has been calling for the exact sequencing we are now seeing in US-Iranian relations via five stages. In his latest post this morning, he writes:
"Iran does not need to win militarily. It needs to sustain disruption at a level that forces the global economy to adjust under constraint."
Sounds familiar. At this point it appears Trump is left with no good options given Iran's ability to precipitate a global energy and economic crisis through asymmetric warfare. Just like Covid, this crisis is manifesting first in Asia, then Europe, and lastly the US. The longer it runs, the more acute the damage. And just like the virus — it's arrival is pretty much baked in when you run the oil balances and time lags for getting ships back in and restarting production (even assuming no damage to facilities). If anything, the success of Iran's strategy appears to have emboldened them as seen in the greater concessions they are demanding than during the February talks.
So why is the market refusing to "look through" near-term TACO headlines to the ultimate North Star here, and instead jamming risk higher? For one, the TACO Misconception is strong because it worked so well during Liberation Day and other events which were entirely crises of Trump's own making — but also situations entirely in his control to reverse. This crisis is not up to him, but investors don't change their minds easily on concepts that have worked so well. Hence, Tom Hanks Has Covid… creation of common knowledge will be required, and when it happens you'll know it when you see it, because the "Can't Print Molecules" narrative will overrun "they can print/spend/negotiate their way out of this" — and possibly quite suddenly.
Beyond the TACO Misconception, Liquidity and Positioning collided near quarter end to touch off the "Risk On" we see now. I believe these factors are A) short term and B) enabling the Misconception around TACO, offramps, and normalization. Of course, maybe I'm wrong and we come home from Pakistan with a Big Beautiful Deal. We'll see. You either believe in the North Star kernel of truth at the center of this giant cartoon, or you don't.
Liquidity & Positioning
I first wrote about the interplay between bank reserves, the Fed's Reverse Repo facility (RRP), and the Treasury General Account (TGA, the Treasury's checking account) two years ago in Liquidity Drains. For newer readers who are uncertain about the mechanics of US liquidity, it is worth reading through the Appendix at the end of the note. Liquidity can be leveraged into a larger frame as described by Michael Howell and others (bond/collateral volatility and other factors play a role in leveraging up risk), but these three factors — Fed RRP, TGA, and bank reserves — are the beating heart of the US system's liquidity. Even shadow liquidity like private credit and direct lending ultimately relies on central bank funding, which ultimately brings us back to the Fed's balance sheet.
To summarize: when the Fed's balance sheet assets are going up (which grows bank reserves), or the Fed's liabilities (RRP and TGA) are going down — liquidity is going up. The white line below is the RRP (inverted), which has now drained to basically zero. The yellow line is the TGA liability (also inverted), while the green line is bank reserves:
Note the 2023-24 period above. In the aftermath of the debt ceiling showdown in mid-2023, Treasury Secretary Yellen then rebuilt the TGA by raising more bonds than spending Treasury money into the economy — thus draining liquidity which would normally show up as declining bank reserves. Except bank reserves did not fall; instead, Yellen's issuance was offset by the decline in the Fed's RRP, even as the Fed was running significant QT at the same time:
Next, notice the decline in liquidity via both the Fed's QT and a rebuild of the TGA in 3Q last year which drained bank reserves by nearly $600bln (Bessent exhausted ~$150bn of remaining Fed RRP, so the drain would have been much greater). I actually wrote about this in Liquidity Drains Redux. Sure enough, we began to see Quant Quakes in July and September along with the choppy selloffs in equities in 4Q. As we approached the threshold for minimal bank reserves, we started to see short-term rates above Fed Funds in 4Q25 (reminiscent of the Sept 2019 repo plumbing problems; red bars = stress):
It was precisely this push above the Fed's rate corridor that suggested liquidity had become too tight — that bank reserves were too low for proper functioning of the system — which led the Fed to abandon QT and initiate its RMP liquidity program in December:
Look again at the first chart… see how the TGA has now drawn down ~$300bn from late last year, and over $200bln just since end of March? Bessent has held debt issuance back in anticipation of tax receipts on April 15th, and supporting risk assets in the process. When you factor in the Fed's RMP injections, bank reserves have risen by ~$250bln since late last year, and over $100bln just in the past 2 weeks:
When factoring in positioning which I will address next, clearly conditions were ripe for a liquidity-fueled, headline-induced ramp in risk (and admittedly something I did not catch in time nor call for):
Which brings us to positioning.
Positioning
This ramp has led many (including me) to question their sanity at how the markets can be a few percent from all time highs and ignore the practically inevitable sequencing of negative knock-on effects from the energy constraints coming.
In the process, this bounce has led fast money hedge funds to dump significant hedges. Here's Goldman yesterday (emphasis mine):
Hedge funds net bought Macro Products (Index and ETF combined) at the fastest pace since May '25 (+2.2 SDs 1-year), driven by short covers and long buys (2.4 to 1). US-listed ETF shorts decreased -11.5% (now down -6% MoM), the largest weekly % covering in the past decade (-3.2 z score), led by covers in Large Cap Equity and to a lesser extent Credit ETFs.
Once again, it appears that short-term lows can be created mechanically, as the sellside is very loud here about how CTAs and vol control funds have tens of billions of stock to buy back (source GS):
…although worth flagging that Deutsche is less aggressive on just how negative positioning has become:
Overall, discretionary and systematic strategies have sold down equities, but with room on the downside when compared to prior durable lows:
On the subject of retail investors, after reflexively buy dips and relentless inflows for several quarters, it would appear they panicked in late March and sold into the hole/bought puts. From Citadel's Scott Rubner earlier this week:
In futures, retail was starting to press net shorts as of Tuesday per the weekly Commitment of Traders, right on the eve of the ceasefire short squeeze pop (I will be interested in seeing how much of this got rinsed out in the back half of the week, though we will have to wait until next Friday):
Source: PauloMacro via Bloomberg
Indeed, the only investor segment that seems to have held on is the slow, long only mutual fund money whose positioning has remained sticky going back to pre-Liberation Day levels:
Overall, equity positioning is in the 27th percentile going back to 2010 — far from Liberation Day, 2022, 2020, 2018, and other key lows, but negative all the same if your view is resolution and rebuilding of bullish/euphoric weights:
In derivatives, equity options trading suggests a pretty balanced put/call ratio (certainly not the depressed conditions we saw on Liberation Day or Yenmaggeddon 2024)…
…though GS is quick to flag that dealer gamma positioning is negative on the upside and positive on the downside (negative gamma dealer positioning accelerates moves, positive gamma dampens them), as a function of the decline in put values vs the fresh call buying we saw in the past few days:
For corporates, after notably declining in 2025, announced buybacks have come roaring back…certainly surprising considering the plunging FCF among hyperscalers:
GS's take is even more optimistic:
I suppose the only wrinkle is how sustainable 1Q declared buybacks will prove to be when input costs are soaring on rising energy. If margins are threatened, will buybacks dry up in classic procyclical fashion? Will cost pass-through work so well?
After all, the current deviation from trend in oil prices has only ever resulted in recessions (100% hit rate unless you believe the world no longer needs energy and it's different this time):
To this end, it's notable that analysts are still taking their estimates higher. How this is possible in the context of the above is beyond me, but the divergence was similar in 2021 as well (as Goldman noted above on buybacks):
Will March's negative positioning require more time to wring out? It's hard to see how we don't extend and climb the "Wall of Worry," especially now that the long Momentum Factor has come screaming back into vogue:
Source: PauloMacro via Bloomberg
As you can see here, the Momentum L/S pair has just ripped to new all-time highs according to Morgan Stanley, and it's dragging the Beta Pair higher with it:
Source: PauloMacro via Bloomberg
That said, it should be said that Momentum L/S is not the be-all and end-all of risk. In the GFC, L/S Momentum continued to work until July 2008:
Momentum Pairs did great too during the Covid crash, and then stopped working until 2Q21:
And the Momentum pair even did pretty well during the challenging 2022 bear market:
The problem I see is that on April 15th, the TGA is going back up as tax payments come out of the banking system, and while the market tends to react immediately on the upside to fresh liquidity but needs time to roll over on declining liquidity (as we saw in 2H25 — reacts like an elevator, drops by the stairs until it trips and falls), the liquidity-induced tailwind from the TGA drawdown will disappear from here, leaving only the Fed's RMP which is a relatively small program. Can this take several weeks to finally be felt by risk assets? Sure, why not. That's what sets up the traditional Sell in May & Go Away phenomenon we see in seasonality.
But another thing that gives me pause is the sudden strong consensus — among both retail traders and sellside shops (GS, Barclays, Vanda come to mind, among many others) — that tech is a "must own" on the way out of the hole from here, as the market will undoubtedly press higher on fading flow headwinds and a stabilizing geopolitical situation (no North Star for the consensus). In the interests of time, my pal Kevin Muir has graciously provided a private link to his latest note on why he does not think Mag7/bigcap tech is where you want to be, and I am sympathetic to his take. Give this a read…Kevin is one of the sharpest around.
But of course, there's always "on the other hand": remember in Intensely Concerned for Risk — with a Catch, in the final section I discussed how major tops initially feature a "Broadening Out" late cycle move into small caps, followed by one final ramp back in the megacaps? We saw this in 1972, 2000, and 2021-22. The relevant commentary is toward the bottom of that note. Could it be as simple as consensus gets what it wants, and we are now in the final move higher in megacap US tech while small-midcaps lag on a flight to perceived defensives in a "cleanest dirty shirt" US rotation back (which makes sense, since Asia and Europe get hit first with the energy crisis)?
So… pick your fighter. The crowd is biased higher, and I don't think we felt The Fear, but maybe The Fear isn't needed anymore in a mechanical world of quants, CTAs, passive ETF inflows, and retail speculation that never seems to run out of ammo.
Still, it's my nature to be cynical. The barrels have been counted, and we are past the point of no return for a major global energy crisis. Once again, there is a Misconception at the heart of the cartoon going on in shipping: the boats coming out don't matter (except to the majority of investors who simply have not done the work) because they have already been counted and sit in the oil balances. It's the boats going back in to sufficiently drain onshore Gulf storage that will dictate when oilfields restart, and restarts are all that matter because shut-in production is lost forever and cannot be made up without many quarters/years of time. The only thing that a resolution of the North Star affects is A) timing around the sequencing of events and B) the acuteness of the crises precipitated by the shortages.
Once again, I wait in suspended animation… with Liquidity & Positioning on one side propelling the financial plate-spinning cartoon, and Can't Print Molecules on the other side… wondering when the two collide and fuse in a Tom Hanks Moment.
I could be wrong about all of this, and spend significant time each day looking for contrary evidence to the North Star. Maybe I'm wrong about all of this. Wrong framework. "The market is always right buddy, it knows before you do…bull market..."
But I am also reminded of something trader JJ likes to say…
"Rallies in bear trends make the market weaker." — JJ, Alyosha
So are we in a bear trend or bull trend? As JJ also likes to say: you decide.
No answers here today, but color me a skeptical barrel counter — one of a million consensus bricks in the Wall of Worry apparently…
Hope everyone is enjoying a nice weekend!
As always, kindly yours,
Paulo aka Cloudbear