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The stock and bond markets face a triple whammy at the end of this month. In this report I’ll show you what those three things are, why and how they will impact the market and what you should do about it (subscriber version only). These three things coming together as soon as xxxxxx (subscriber version only) will pose a grave threat to the Treasury market, to short term interest rates, and ultimately to the stock market.
We’ll focus on the threat to the bond market, and touch on the threat to trigger a rise in short term rates. Just keep in mind that stocks won’t be immune.
In view of Friday’s BLS nonfarm payrolls “surprise,” there’s another factor I want to feature in this report. Tax data is fact. The BLS jobs data is fiction. It’s constantly repainted after the fact to represent past reality, but it is not current reality. Taxes are facts. BLS jobs estimates are SWAGs based on severely flawed methodology. They rarely accurately represent actual current conditions, and then only accidentally.
Furthermore, the jobs data is irrelevant for our purposes. It is tangential to the knowledge we need to understand and successfully trade the markets. Supply and demand rule the prices in the securities market, just is they rule the commodities markets, real estate, labor, and the day to day prices of the things we buy. Each market has its own forces of supply and demand.
For Treasury prices, and their inverse, yields, we’re interested in the supply of Treasuries, and the demand for them. There’s no need for secondary or tangential data. We have the primary data. We know the near term supply outlook, because the Treasury publishes it in advance. We can estimate how it might change because we have the real time data on Federal revenues, and outlays, and hence the budge deficit and future issuance needs.
We don’t need the silly exercise of pretending to know how many jobs were created each month. We have the withholding tax data. That’s the primary data that tells us how much revenue the Federal Government is taking in, and whether it’s increasing or decreasing.
We saw in July that those revenues had decreased sharply. Because we watch the real time tax data, we were ahead of the curve in recognizing that the economy had slowed. Sometimes, being aware of change before the Street and the public are, is helpful.
The picture for August is more complicated. When we dug into the numbers, we saw that withholding taxes continued to show signs of slowing. This means that the trend could be shifting toward less revenue, and what that means for the bond market (subscriber version only). I wrote the following last month. It remains on point.
8/4/21 If this softening in the economy is more than a blip, it will become a huge, festering problem when the debt ceiling is lifted, because it means that the Federal deficit would widen. That would mean more Treasury supply as opposed to less if the economy were strengthening and revenue was growing. Obviously, more supply would require more Fed QE, not less. Otherwise, bond prices would fall and bond yields would rise. The system is in no condition to withstand such a scenario.
The next problem is that the Federal Government should run out of cash in xxxx xxxx (subscriber version only). At that point, it must raise or suspend the debt limit. The Treasury will then begin issuing a torrent of supply to replenish the accounts it raided under the “extraordinary measures” it has undertaken since July 31 to avoid exceeding the debt limit.
The pile of cash in the Fed’s RRP program will act as a slush fund to buy the new T-bill issuance. There are a number of moving parts to the outlook for what happens then, including the mix of T-bills versus coupons in the new issuance schedule. Likewise, we don’t know for sure how holders of RRPs will react to any of this. We have no historical precedent to guide us.
The impacts could vary. Either short term rates, or bond yields could rise first. We should see the first hints of market impacts immediately upon the lifting of the debt ceiling. But one way or another, once the RRP cash is gone, the real problems will mushroom.
By then it could be too late. It’s possible, even likely, that significant market damage will already have occurred. Here’s when we should be prepared to act (subscriber version only). If I owned long term bonds I’d xxxx xxxx xxxx (subscriber version only). Or I’d need to be willing and able to hold to maturity while suffering the loss of purchasing power that rising inflation would entail.
Meanwhile, I would keep a close eye on stock market technicals for any sign that it’s time to stop trying to ride that bubble wave any further.
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