Category: 1 – Liquidity Trader- Macro Liquidity

The last time we looked at the Composite Liquidity Indicator (CLI), 4 months ago, I warned that the process of flattening the indicator was beginning, and that that would lead to bad things happening. Those bad things have been under way for a couple of months, but they have barely scratched the surface of the potential of what’s to come as this line turns flat. See chart (subscriber version).

The stock market is approaching the low side of its normal band of motion from the CLI. If history is any guide, the stock market will remain vulnerable to further severe declines until a week or two after the line representing the S&P 500 penetrates the bottom of the normal range of motion from the liquidity line.

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Then we face the prospect that liquidity could be even tighter than during the period of October 2017 to September 2019 when the Yellen Fed was temporarily “normalizing” its balance sheet. See chart (subscriber version).  The Fed is again threatening to begin shrinking the balance sheet. But this time around the market must absorb a far higher amount of new Treasury supply than it did in 2017-19, when the Fed last tightened.

Shrinking the Fed’s balance sheet now would pull cash out of the banking system, causing deposits to at least turn flat, if not shrink outright. I would have to bet that the Fed will never get to that point. The effects of merely holding QE at zero will be bad enough.

As for the War in Ukraine, it’s not helping, but stocks were already down nearly 9% the day that Putin attacked. Furthermore, historically, periods of war have been bullish for stocks. That’s because central banks have typically printed reams of money during wartime. Today, the Fed doesn’t have that luxury, with the  CPI headline print almost 8%, and actual inflation at least 13%.

Wars don’t drive asset price trends. Central bank policy drives asset prices. Today, central banks simply cannot be easy during this wartime because of the devastating inflation already under way.

Under these conditions, where systemic liquidity stays flat, at best, my bet would be that we will see cataclysmic selloffs in stocks at times. Violent rallies will follow, but will inevitably result in lower highs.

Led by the Fed, the world’s biggest central banks have painted themselves, and us, into a corner. They can no longer continue to tilt the playing field in favor of the continuation of a long-running secular bubble. The consequences would simply be too dire.

On the other hand, there will be equally terrible consequences for maintaining tight policy. And I’m not talking about how much they raise interest rates. That’s a sideshow that is an effect of tight money. The market will tell the Fed what to announce about rates. It must simply rubber stamp the market, lest the public realize that the Fed doesn’t control rates the way that it wants the public to think that it does.

Now the Fed is not printing enough money to absorb virtually all new Treasury issuance, with additional cash left over to support stock prices. If it sticks to this new policy of no QE, money rates will rise. Bond prices will fall and yields rise, margin calls will go out. Stock prices will fall. More margin calls will go out. And so on.

But only when consumer prices start to fall will the Fed be able to resume QE. By then, asset prices should be much lower than they are today. Therefore, I will continue to focus on looking for good short to intermediate term stock xxxx xxxxx (subscriber version).. I would continue to xxxx xxxxx (subscriber version). the bond market xxxx xxxxx.

Even bondholders who hold to maturity will get robbed. Inflation will eat them alive.

Will gold be a long term hedge for all of it? In theory, it should be, but we all know about the difference between theory and practice. Meanwhile, the long term charts of gold and some gold mining stocks look more bullish.

I’ll continue to use technical analysis in the Gold Trader reports to try to identify when this gold bull breakout is overdone. And I’ll continue to look for good entry points for getting long the mining stocks.

Meanwhile, none of this has come as a surprise. We were forewarned.

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I’ve been doom scrolling my newsfeeds for the past few days, not getting much work done. What a catastrophe. War in Europe, just 120 miles from where I was living a few short weeks ago.

I just communicated with a Ukrainian friend who lives in Kyiv and owns a number of apartments there. She left the city with her family on Thursday, for what she felt was greater safety in the west of the country. She said that the Russians are shelling and firing missiles at civilian targets indiscriminately, and that many ordinary people have died. She called Putin crazy. Then she noted how proud she was of her countrymen for their firm resistance.

I made several friends in Eastern Europe during my 26 months living there. I got to know their attitudes toward Putin and the Russians. My friends are all older people. They lived for decades under Russian domination. They love freedom and they hate the Russians viscerally. They will never surrender, even if Russia finally dominates in this conflict and subjugates them.

The question for us here is how this will impact monetary policy. We already know that the Russian central bank will be blocked from moving money, and that some Russian banks will be blocked from accessing the international payments system. No doubt this chaos will trigger a roundabout detour in the Fed’s tightening policy.

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But will they actually reverse and return to QE? We’ll have to see what’s next. I would suspect that most of the easing would be directed at their cohort, the ECB, and other central banks. My guess is that they won’t immediately return to outright QE, pumping money into Primary Dealer accounts again, at least not right away.

The Fed is boxed in. It faces the prospect of an international financial crisis. It faces the reality of 40 year record inflation that has the prospect of worsening. We’ll watch what the Fed says because it will lead us to what they’ll probably do. Although in emergencies, the doing comes first. And markets respond to the doing, not the talking, despite what the Fed and the high priests of Wall Street want you to think.

So unless they pump money directly back into the markets via buying securities from Primary Dealers, it won’t reverse the course of the financial markets. Bond prices will still xxxx xxxxx (subscriber version). and yields xxxx xxxxx. Stock prices will have their usual April seasonal bump from tax revenues being used to pay down Treasury debt for a few weeks. Then they’ll xxxx xxxx.

I believe that unless the Fed returns to buying paper from the dealers, that course is set. If they do return to QE, I’ll wait and see what the market response is. Normally I’d say it would be a go, bullish. But the dealers still have the option of simply paying down debt with the proceeds of selling their Treasuries and MBS to the Fed. If they were to do that, game over.

Meanwhile, I say what I’ve been saying for the past 18 months. I would continue to xxxx xxxxx (subscriber version) bond market. If I had any long term bonds in my portfolio, which I don’t, I’d xxxx xxxxx.

There are, of course, ways to xxxx xxxxx the bond market. I’d rather xxxx xxxxx stocks. Just my preference.

Stocks will have rallies. I’ll use the TA to xxxx stocks for swing trades when they look good for that. I’ll continue to report weekly on that, and the overall technical market outlook in the Technical Trader reports.

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The Federal budget deficit is shrinking as the economy experiences an inflationary boom. This is just what the Fed was hoping for, but inflation has obviously gotten away from them. It will only get worse as the lagging rent component of CPI will push the total index higher, even if and when the other components begin to moderate.

The rent of shelter and owner’s equivalent rent that’s based on it make up about 40% of Core CPI. Those two components are not based on real time market rents. They’re based on a survey of renters, asking them what they’re paying. The OER is derived from that as a base, and then adjusted from time to time by asking homeowners how much they thought their houses would rent for… As if they knew.

This isn’t merely a dumbass way to measure rent inflation, it’s fraud. Contract rents are usually adjusted upward at a rate far below the increase in market rent. That’s because landlords like to keep good tenants in place rather than incur the friction costs of raising the rent too much and having them leave. It costs money to find a new tenant, and spruce up the unit.

So when the BLS asks tenants what they’re paying, it does not get the full effect of the currently soaring rents. Apartment List does a national rent report showing rents up 17.8% year over year. BLS has imputed the rent component of CPI at 4.1%. At 40% of core, this difference means that the BLS is understating total Core CPI by roughly 5.5 percentage points. That’s obscene. It’s an affront to human intelligence.

But CPI was never intended to measure inflation. That’s why they took home prices out of the index in 1982. CPI was always intended as a tool for indexing government wages and benefits, and industrial labor contracts. In the 1970s indexing got too expensive as home prices surged. So they worked out a way to remove house prices and falsify the housing component of CPI beginning in ‘82.

Now, the Fed is devaluing the mountain of debt out there. Bond holders will get a small fraction of their purchasing power back if they hold to maturity. And if they don’t, and sell along the way they’ll get killed on the capital loss as a result of collapsing bond prices.

We saw this coming since about a month after the bond market turned in August 2020. I don’t think it will get better any time soon, although certainly there will be bond rallies from time to time. Still consistent with my message of the past 18 months, they’ll be xxxx xxxxx (subscriber version).

Meanwhile, the budget deficit will narrow as long as the economy booms. That will reduce Treasury supply. But it won’t reduce it to $20 billion a month. Maybe it will fall to an average of $60 billion per month as some forecasts suggest. Maybe it won’t. I don’t know. The economy is booming at the moment, and there’s no reason yet to expect a slowdown.

But it doesn’t matter. Because the market has shown that it can only absorb $20 billion per month while the Fed kept bond prices stable and suppressed by buying or funding $180-$200 billion per month in net new supply.

Now, if the Fed isn’t buying, and the market can only absorb $20 billion per month, with supply even as low as $60 billion, that’s $40 billion in excess supply that the market can’t take at a stable bond price.

Therefore, bond prices will xxxx xxxxx (subscriber version) and so will stocks, as they get xxxx xxxxx . They’ll be xxxx xxx xxxxxxxx xxxxxxxxx on leveraged funds who hold both stocks and fixed income. And they’ll get xxxx xxxxx because eventually rising yields will force some money managers to xxxx xxx xxxx xxxxx.

There will be no xxxx xxx xxxxx, except to xxxx xxxxx (subscriber version). I’ll continue to look for xxx xxxx trading opportunities in the Technical Trader reports. I’ll leave xxx xxxx the bond market to whale hedge fund professionals.

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FREE REPORT – Proof of How QE Works – Fed to Primary Dealers, to Markets, To Money

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There’s more evidence in the weekly data on the biggest US banks .of the sea change in psychology and financial conditions that is triggering this bear market environment

The Fed is mandated to control inflation. That means that it has no choice but to follow the conventional economic prescription for doing so. Tight money.

Tight money means death, destruction, and chaos, given how much debt and leverage now overburden the banking system in general, and the Primary Dealers in particular. As they become increasingly stressed, the effect will show up in the markets as lower prices. That will increase the stress, and so on.

The Fed will have its hands tied as long as the CPI and PCE measures remain elevated. Therefore, a resumption and continuation of the crash that has already begun in both stocks and bonds is baked in. It won’t be a straight line. There will be rallies, and they will represent profit opportunities for those willing to short them when they run out of steam.

The big surprise in this data is the evidence that both Primary Dealers and money managers are already hoarding cash. This is a reversal of their past behavior of immediately redeploying cash when speculation and bullishness ruled.

If this is the new mindset, we’re about to reap the whirlwind. Here’s what to do, along with the supporting charts, data, and analysis to help you understand what’s really going on behind and beyond Powell’s tortured dissembling.

Find out what to expect now and what to do about it in this report.

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KNOW WHAT’S HAPPENING NOW, before the Street does, read Lee Adler’s Liquidity Trader risk free for 90 days!

Act on real-time reality!

FREE REPORT – Proof of How QE Works – Fed to Primary Dealers, to Markets, To Money