Category: 1 – Liquidity Trader- Macro Liquidity

Federal tax collections plunged in May, withholding taxes in particular. Those worried about a slowing economy now have real data to back them up. In fact, the consensus of worried economists isn’t worried enough. That consensus is for a gain of 328,000 jobs, versus 428,000 in April. But regardless of what the BLS’s, seasonally adjusted, randomized, and otherwise statistically tortured non farm payrolls report shows, the reality is much worse.

That reality is tax collections—actual hard data, in real time, and not statistically massaged. And they were down. Big time.

This means that, if reported accurately, subsequent economic data reports will be weak. They should show economic contraction. So the economy is contracting but inflation isn’t yet. Bad combination. But it’s not enough to give the Fed an excuse to reverse policy.

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The Fed typically isn’t quick enough on the trigger to respond to economic trend changes, and it has not yet shown any propensity to rescue the financial markets in this cycle.

I’ve warned about this before. Eventually weakening financial markets would trigger economic weakening. These two facets of the monetary coin are tied at the hip. Central bank tightening triggers visible effects first in the financial markets. But nearly concurrent effects, or at most slightly lagging, occur in economic activity. They’re just not as visible and as obvious at first. Mostly because economic data lags. But also because the initial economic changes are more subtle than the more visible changes in stock and bond prices and yields.

Furthermore, government agency statistical manipulation of the data adds a random element that often creates the misimpression that the economy is doing better or worse than it is. We don’t have that problem with the tax data. It is what it is.

Now we have the first real, hard data that shows that the economy is in fact weakening, along with the financial markets. But we have yet to see any evidence that inflation is coming down.

The Fed is now in that Catch 22 phase that we knew had to come. And because of the fraudulent way that the Federal Government economic reporting agencies report inflation, the popular inflation gauges will lag as inflation moderates.

The Fed will follow the reported data, so it will be slow to respond to disinflation, when it comes, just as it was slow to respond to inflation, even after it was obvious. The Fed just refused to believe. It will likely be equally disbelieving in accepting the first signs of disinflation.

So the adverse monetary conditions are likely to persist until after financial markets have passed the point of no return. Don’t pin your hopes on economic weakness to rescue the markets. Stay focused on monetary policy, and on liquidity. This report show exactly what the real data is telling us. It shows the impact of that, the implications for the trends of stock and bond prices, and it gives you clear analysis about what to do about it to protect, and even grow your capital under these conditions.

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The gradual flattening of the CLI is now visible. Starting in June, it should turn negative. The Fed will begin literally removing cash from the banking system and the markets in June, when it starts shrinking its balance sheet. That will have ripple effects in at least 3, if not all 4, or the components of the CLI.

In the meantime, however, stock prices have gotten ahead of the curve. They are now oversold versus the historical norms of the liquidity band over the past 13 years. Does it matter? Or is this a new paradigm?

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No question it’s a new paradigm. The Fed has ended, for the foreseeable future, its previous 12 year campaign of aggressively adding money to the financial markets in its program of inflating asset prices.

It had a trial run of this policy once before from October 2017 to December 2018, but stocks were bubbling then and the ECB and BoJ were still printing massively. That help from the rest of the world kept US markets liquified, resulting in a series of overbought readings that lasted 22 months.

The market cracked a bit in the middle of that tightening experiment, and finally fell apart when Covid 19 came around. The Fed then panicked and opened the QE floodgates. Now, we’re reaping the whirlwind from that.

As the Fed persists in tightening, in its fight against CPI inflation, my thought is that if the market can stay overbought versus liquidity for most of 22 months, it can stay oversold against it for just as long. However, with the oversold condition comes the likelihood of vicious vertical spike rallies along the way, as overconfident short sellers load up on their positions.

When they do, and the market starts to rally, they’ll spontaneously combust, driving inexplicably big advances in stock prices. Wall Street will come up with all kinds of recovery narratives to justify those rallies, but they will merely be, as Joe Granville called them, of the genre, “The Rally that Fools the Majority.” I’d make that plural, because of the probability that there will be more than one of those before this bear market is finished.

This report lays out in graphs and clear analysis, just what you should expect in the weeks and month ahead, along with how I’m approaching both the short term tactical aspects, and the longer term strategic approach for both stocks and bonds.

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Federal tax collections were once again extremely strong in April, including withholding taxes, and individual non-withheld income taxes in particular. In fact there were strong gains in all types of taxes.

This means that, if reported accurately, subsequent economic data reports will be very strong. The weak Q1 GDP was an artifact of a slowdown in February. That was reversed in March, and they added on in April.

You may think that this strong economic data is good news for the markets. But it’s not. A red hot economy will continue to feed raging inflation. The Fed xxxxx xxxxxxxx xxx xxxxxx xxxxx tightening policy.

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The markets will get a brief respite thanks to seasonal Treasury paydowns but after that, the tightening monetary conditions should have xxxxxxxxxx xxxx. Non-subscribers, click here for access.

The Treasury just posted its quarterly refunding requirement for the balance of this quarter and for Q3. New Treasury supply will fall sharply. That surprised some Fintwit “experts.”

That’s something that we knew would happen and even predicted here in these reports, simply because we follow the Federal tax collection trend in real time. This isn’t rocket science. It’s published real time data. Track it and whack it. That’s what we do. And it gives us an edge.

One analyst went so far as to predict that because of this “surprise” supply reduction, this is the bottom. Well, it’s not a surprise. And its not the bottom. Primary Dealers and other members of the TBAC- the Treasury Borrowing Advisory Committee, all knew this was coming. AND YET, they still sold bonds.

It’s simply the law of supply and demand at work. The market can’t handle the truth. And never ending supply in excess of demand is a fact. Any excess of supply over demand is a problem. Even massively reduced supply, when the Fed isn’t standing in the middle of the pit taking all of it, leaving only a pittance for the market to absorb on its own.

The fact is that bond yields were only stable at low levels when the Fed was directly buying or indirectly funding more than 90% of net new issuance. Whenever the Fed reduced that percentage, bond prices fell and bond yields rose.

Janet Yellen gave us a demonstration in the 2017-2019 attempt at “normalizing” the Fed’s balance sheet, bless her heart. Powell shit his pants when the 10 year went over 3%. But then he wasn’t dealing with 8% headline inflation prints, which doesn’t include housing inflation running 20%. They suppress that. Now that he’s dealing with this inflation monster he’s crapping himself again, but this time he’s forced to tighten instead of easing, which is his more natural response.

So, since March, the Fed has essentially left the Fed Puts building. It’s still buying MBS, but not enough to keep the bond market price needle from collapsing and the yield needle from soaring.

Price and yield are the meters of supply and demand in the markets. They tell us what’s happening in the Treasury market trading pits. The direction of price is the direction of the relationship between supply and demand.

The Fed has left the trading pits, leaving the markets in the pits. And soon, perhaps as soon as the next week or two, the Fed will actually force the Treasury to increase the amount of supply it offers to the public. The Treasury will have to do that in order to pay back the Fed, when the Fed starts redeeming up to $60 billion per month of its maturing holdings of Treasuries, and another $35 billion of MBS that someone in the market will also have to buy in the vacuum left behind by the Fed.

With no help from the Fed, and despite sharply reduced Treasury supply, fixed income prices have been crashing. The Fed is about to begin piling on to that trend. So forget about the fact that tax revenues are soaring and Treasury supply is shrinking. It’s not shrinking enough to xxxxxxxx xxxxxxxxx xxx xx xxxxxxxxxxx xxxx xxxxxx xx xxxxxxxxx. Non-subscribers, click here for access.

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The bottom line is still: XXX all rallies. That goes for both bonds and stocks.

Late Addition- As I was preparing to post this, the TBAC issued its supply forecast. Yes they’re cutting issuance, but there will still be net new coupon supply of $153 billion May 16-31. And $171 billion June 15-30. https://home.treasury.gov/system/files/221/TBACRecommendedFinancingTableQ22022-05042022.pdf In Q3 they see net new coupon supply of $335 billion. The paydowns will all be in T-bills, as they have been. This will have no impact on the outlook as we have been seeing it. https://home.treasury.gov/system/files/221/TBACRecommendedFinancingTableQ32022-05042022.pdf

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The Treasury Borrowing Advisory Committee (TBAC) told us in early February that it estimated that the US Treasury would pay down $358 billion in T-bills in the second quarter. That’s a lot of cash to stuff into the accounts of money market funds, banks, Primary Dealers, and other investors who use T-bills as a near-cash holding.

There’s nothing unusual about that. It’s an annual occurrence. The Treasury gets a tax windfall in March and April and uses the money to temporarily pay down outstanding T-bills. Those paydowns stuff cash into the accounts of those holding the expiring bills that are being redeemed. Then those former holders of the bills must find a place to reinvest that cash.

There are fewer T-bills in the market for them to roll into. When the Treasury pays them off, they’re gone. Poof. The Treasury will only start issuing new T-bill supply in a couple months when it needs to start borrowing short term again to fund government spending. Meanwhile, there’s a surfeit of cash in the accounts of money funds, banks, dealers, and investors.

Some recipients of the paydowns buy bills in the secondary market. That pushes the rate down. Some roll out a bit on the yield curve toward longer maturities. That normally pushes short term coupon paper, such as the two year note, prices upward, and yields lower. That buying ripples out through all maturities along the curve.

And a few at the margin decide to park the cash in stocks, which pushes stock prices up.

As a result of that process, we invariably saw rallies around the time of annual tax collections. Likewise, in the third week of every month, the Fed added to the cash tsunami with its regular settlement of its previous forward MBS purchases under QE. Because there’s a built in lag in that process, even though outright QE has ended, there was still a big Fed MBS settlement last week totaling $98 billion.

All told, there has been a helluva lot of cash pumped into the market in the past couple of weeks. But the markets have not rallied as I have expected them too.

Apparently, I missed something important. It’s obvious, but I underweighted the fact in my thinking. Here’s what it is, why it’s a huge deal, and what it tells us about how to trade and invest to protect, and even grow, our capital.

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After a disastrous couple of months in the bond market, conditions are now set up for x xxxxxx  there. Treasury bill paydowns will be enormous over the next month. No one expects this, because the market has been so horrible, and the Fed is so tight and will soon get even tighter. But the markets will be xxxx xx xxx from these Treasury paydowns. They’ve already started, and they will surge to enormous levels over the next 2-3 weeks.

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So what would I do with this information? The same thing I’ve been doing for the past 20 months. They’re gifts to us on the way to Dante’s Inferno. If I owned bonds, I would xxx xxxx. If I owned stocks, I would xxxx xxxx. And I would keep looking for stocks to xxxx on the xxxxxx.

I know. Cash is trash when inflation is high and interest rates are negative to inflation, but it’s less trashy than assets that are actively losing value. The strategy that I think makes the most sense in such an environment is to trade stocks from the xxxx side. I publish the weekly swing trade chart picks for those who are looking for ideas along those lines.

Meanwhile, the Primary Dealers are STILL positioned wrong. They’ll get this little rally in the short run to help salve their wounds. But I stress – short run.

Dare I say, “Sell in May and go away?” But make that the xxxx xx xxxx. The Treasury paydowns should continue lubricating the market well xxxx xxxx xxxx.

The problem after that is that the Primary Dealers and the biggest banks who own them have enormous hidden losses that aren’t showing up yet on bank earnings statements or balance sheets. As market conditions tighten in the second half of this year and margin calls beget losses, which beget more margin calls, those hidden losses will start to show up. Banks will be forced to liquidate some of their assets and will be forced to report some of those losses.

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