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Secretary Yellen Says that the Treasury will run out of cash on October 18. Sounds about right.
When the Treasury runs out of cash, Congress will be forced to raise the debt ceiling. When it does, look for a xxx xxxx xxx xxxx xxx xxxx (subscribers’ version).
Given the current political climate, a government shutdown is a given. A delay in lifting the debt limit, and a technical default by the US government is a definite maybe. It would almost certainly be disruptive to the markets in the short run, but in the longer run, the default will be cured, and the effect will fade into the background.
The Fed’s RRP slush fund is now nearly $1.5 trilllion. I had forecast that it would top out around $1.3 trillion. Bulls get a bonus. That will fund the new supply tsunami for xxxx xxxx (subscribers’ version) months. Everything could look ok during that time. The Fed will be praised for its brilliance, and the markets will have an uneasy peace, if not a resumption of bullish trends.
However, as that fund begins to run out, the cracks will appear. And once that fund is drawn down to zero, the ingredients for a massive xxxx xxxx xxxx xxxx (subscribers’ version) will be in place. The bitter fruit of QE, and tapering QE, will be tasted.
The timing of that depends largely on how fast the Treasury xxxxxxxxxx xxxxxxxxxxxx xxxxxxxxxxxx xxxxxxxxx (subscribers’ version). So far, that amounts to at least $600 billion to be added to structural supply needs over the course of a few months.
This month, the Fed’s QE has been covering, and will continue to cover 104-107% of new Treasury issuance, until the debt ceiling is lifted.
That should have been a short term bullish factor for bonds and stocks, as it pumps cash into the dealer and other institutional accounts that had been the holders of the T-bills being redeemed. But it hasn’t gotten traction. Smart money is getting out ahead of what they know is coming. The xxxx xxxxx (subscribers’ version) situation plays a role in generating margin calls that trigger liquidation pressures in other assets xxx xxxx xxxxxx xxxx (subscribers’ version). That includes especially, highly liquid US assets.
Another factor pressuring prices is record corporate debt and equity issuance.
Previously I wrote:
8/26/21 In fact, it’s surprising that the stock rally has been so muted, and that the bond rally has stopped in its tracks over the past 6 weeks. That’s because corporations have been rushing to issue new equity and new debt to take advantage of the high prices they can get. This is free money to them.
9/15/21 I had forecast this last year, and have reported on it several times this year. Just this week we began seeing mainstream media news reports confirming record levels of corporate issuance.
8/26/21 Once the Treasury begins to issue new debt, it will be on top of this gigantic wave of corporate supply. It won’t be pretty.
It also won’t be immediate. I estimate that by the time the debt ceiling is lifted and the Treasury supply tsunami starts, the Fed’s RRP slush fund will reach about $1.3 trillion. That’s how much new Treasury debt can be issued before the crisis becomes apparent.
8/26/21 We have a few months. Xxxxxx xx xxxxx xxx xxxx (subscribers’ version), but we’ll have the meters of the Fed’s RRP account, and the schedule of new Treasury issuance, as well as the QE schedule. If the Fed chooses to reduce that schedule, that’s their problem, and the market’s.
But it won’t be ours. Because we’ll be actively watching, with situational awareness. We’ll hopefully be prepared to take advantage with enough advance notice to act accordingly.
9/15/21 It’s been reported that the Fed will begin its “taper,” which are small reductions in the amount of QE purchases it makes, in November.
Meanwhile, the 10 year Treasury yield has broken out to the upside. We expected that. But I didn’t expect it to happen this quickly. I attribute it to front running, xxxx xxxxx (subscribers’ version), and record corporate issuance, all of which are sucking money out of the market as fast or faster than the Fed pumps it in.
In conclusion, I repeat what I wrote in mid September. 9/15/21 It’s a recipe for disaster. So I reiterate my view that xxxx xxxx xxxxx xxxxx xxxxx xxxxx, (subscribers’ version) a view that so far, appears to have been remarkably prescient.
Below are a few previous summary observations which remain relevant. Supporting data, charts and analysis follow that (subscribers’ version).
8/13/21 The Wall Street talking head community, with a few Fedheads chiming in, is now in a growing chorus that the Fed will start tapering soon. Our analysis has been that the Fed can only taper if the Federal deficit is shrinking, thereby reducing Treasury supply. If the Fed were to taper in the face of constant or rising supply, the market would need to adjust in order to absorb the additional supply. Bond prices would fall and yields would rise.
This is where the revenue trend is important. If it weakens, the deficit will grow and supply will increase. This is even before considering the infrastructure spending package. If revenue growth stays strong, the Fed could conceivably do a small cut in QE (aka taper) without crushing the bond market. That could turn into the muddle through scenario.
The Treasury market rally of recent months has meant that Primary Dealers have built a profit cushion that would provide some protection in the event of bond market price weakness. In addition, initially, the supply increase that results from the lifting of the debt ceiling will be funded by the trillion + dollars that has been deposited in the Fed’s RRP program. That is still growing as the Treasury continues to pay down T-bills.
Those two factors will delay a bond market crisis for a couple of months. It’s difficult to estimate for how long, with any certainty.
It depends on when the debt ceiling is lifted, how much tax revenue the US economy is generating, and how much the Fed cuts its purchases of Treasuries and MBS as it begins the “taper.”
A muddle through scenario is always possible, but a crisis is also possible, if not more likely. The timing is in question, but it should come xxxxxxxxx xxxxxxx xxxxxxxx (subscribers’ version). The timing will become clearer as the trends of the data begin to show themselves once the debt ceiling is lifted. That includes the supply schedule, the trend of Federal revenue, and the Fed’s schedule of reduced purchases.
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