Lee AdlerFederal tax data tells a story the BLS doesn’t: employment growth is stalling, corporate profits are getting squeezed by tariffs, and a ballooning deficit shows no sign of moderating — with war costs making it worse. That can mean only one thing.
The tide that floated all boats for three years is receding. The perpetual motion machine that debt built is running in reverse. The Treasury basis trade that quietly financed the federal deficit while fueling a three-year equity bull market began unwinding in September 2025, and the liquidity architecture it supported — repo, foreign central bank demand, and speculative equity commitment — is now deteriorating simultaneously, with no replacement buyer in sight.
The Treasury market faces growing fragility as Primary Dealers are forced to absorb a relentless supply of government debt. To manage this “deal with the devil,” dealers have turned to extreme financial engineering, ballooning their leverage through repo markets and complex hedging to keep prices stable. However, this mountain of offsetting long and short positions has created a precarious equilibrium; any sudden widening of the narrow gap between cash and futures markets could trigger a rapid, uncontrolled unraveling of hedges.
The federal budget deficit continues to expand as government outlays outpace revenue gains. Withholding tax collections grew strongly, belying the BLS nonfarm payrolls data for February. The tax data indicates a stable employment trend.
The Fed is doing just enough. Repo growth has flattened, leverage may be unwinding, and long term liquidity/sentiment measures remain historically extended. Yet nothing has broken. The bull is on life support, and the next 60 days will tell us whether the seasonal liquidity tailwind buys it another leg or the exits start getting crowded.
The Fed’s ~$50–55B/month in outright T-bill and T-bill buys to replace MBS prepayments has been sufficient to offset the withdrawal of the hedge fund Treasury basis trade. Hedge funds have cut short Treasury futures positions by 600,000 contracts since September in the 10 year Treasury futures alone. So far the Fed is winning the battle to hold the line.
I’m having cataract surgery Tuesday afternoon. Since I’ll be out of commission for a few days, I wanted to give a quick overview of the Treasury supply outlook for the next 3 months.
February is normally a month of big supply because taxpayers expecting big refunds are motivated to file early, resulting in heavy cash demands on the Treasury. That normally means more debt issuance, with resulting pressure on bond and stock prices.
The latest budget and liquidity data suggest a generally stable backdrop, yet several underlying indicators point to potential early-stage warnings that merit close attention.
The U.S. financial system is locked in a high-stakes feedback loop where massive Treasury debt issuance is driving stock prices to historic extremes. Fueled by a trillions sized leverage trap in the repo market, this “perpetual motion machine” of asset inflation has pushed market risk indicators to levels rarely seen in history.
The U.S. financial system is locked in a high-stakes feedback loop where massive Treasury debt issuance is driving stock prices to historic extremes. Fueled by a trillions sized leverage trap in the repo market, this “perpetual motion machine” of asset inflation has pushed market risk indicators to levels rarely seen in history.
Liquidity remains adequate, but historically stretched. Markets are still functioning smoothly, but the system is increasingly fragile because asset prices are being levitated by financial debt-driven money creation resulting in never-before-seen pricing excesses.
The latest budget and liquidity data suggest a generally stable backdrop, yet several underlying indicators point to potential early-stage warnings that merit close attention.