The conditions for a rally in bonds were there, only the will was missing. That finally showed up last week. Meanwhile, the dealers finally meaningfully increased their short positions in Treasury futures. Voila! There were enough shorts, and enough short covering, to trigger a rally upon the reappointment of the Chairman of the Fed Moral Hazard Bubble, Jerome Powell.
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Of course, any hopes on which this rally are based, are ill placed. Those hopes will not come to fruition. The Fed is hellbent on continuing to tighten, as it must, to meet its mandate to control consumer inflation. It is a long, long way from meeting that mandate. It’s a long way from engineering any rescues of its bank clients and market fronting strawmen, the Primary Dealers.
Meanwhile the parent companies of the dealers, the big banks, have hundreds of billions of dollars of losses buried in their bond holdings. These are in their long term portfolios, which are not marked to market.
As the Fed begins actually withdrawing cash from the banking system via its “Quantitative Tightening” or QT program, some of these holdings with losses will need to be liquidated. Depending on how the banks structure their bond inventory accounting we may or may not see those losses. But whether we see them or not, they’ll be there, and they will place further strain on the banking system, pressuring the banks to deleverage by selling assets.
That includes their Primary Dealer subsidiaries, who have been reducing, and will likely continue to reduce, their bond inventories. Those inventories have already collapsed, both from selling and from mark to market losses, which are required for dealers.
While this has been going on, there’s been another factor which should have played an ameliorating role. It hasn’t. And we now know that it won’t.
As a result, after a brief respite, market conditions will soon get worse. Here’s why, along with how it will play out, and what to do about it.
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