We’ve been in a bad bear market in stocks for over 6 months. And a really bad bear market in bonds for almost two years. It could have been worse. Why hasn’t it been? Because even though the Fed hasn’t been absorbing any Treasury supply, supply has been so light that stock and bond prices have reached an equilibrium range. It’s been volatile. It’s been unsteady. But it hasn’t collapsed.
In June, the Fed began actually withdrawing cash from the banking system at the rate of $47.5 billion per month. They call it QT, or Quantitative Tightening. $30 billion of that is in Treasuries, and $17.5 billion is in MBS. They plan to double those amounts in September. I’m doubtful they’ll even get through August, but we’ll see.
Reason number one that the end of QE and beginning of QT has not triggered a collapse is that these withdrawals are not simply the opposite of QE. QE was injected into the financial markets directly through the conduit of bond purchases from Primary Dealers. The Fed paid for the purchases by crediting the dealers’ accounts at the Fed with new cash. The dealers than used that cash to accumulate more securities, promote and mark up those securities, and distribute them. As long as the Fed was pumping money into dealer accounts, this process pushed stock and bond prices higher.
Under QT, the withdrawals are not done in trades with Primary Dealers. The money is not sucked directly out of dealer accounts. The QT process only hits the dealers indirectly, and in reduced amounts relative to QT.
The Fed withdraws the money from the financial system by telling the Treasury to repay some of its debt to the Fed. The Treasury must raise the cash to repay the Fed through sales in the market. The buyers of the new paper pay for it by withdrawing cash from their bank accounts. The Treasury sends that cash to the Fed in repayment of the debt. And just like that, the money disappears into the Treasury Black Hole Account.
OK, I kid. It’s not a black hole, but the effect is similar. The Fed sucks the money in, and it disappears from the financial universe. Indeed, the Fed can make it reappear whenever it wants to, but for now, it’s like the South Park episode where Kyle deposits $100 in a new bank account. And it’s gone. The banking system shrinks. There’s more Treasury debt to be absorbed week in and week out, and less cash to absorb it week in and week out. Drip, drip, drip.
Only the boyz have had it good since March. Tax collections have been so enormous on the big quarterly and annual tax due dates that the US Treasury has been able to continue paying down T-bills at a rate in excess of $100 billion per month. Withholding taxes also surged in June.
The result has been that net Treasury supply of coupons less the bill paydowns has only been in the neighborhood of $30 billion over the past month. In April and May, and part of June, the Treasury was actually disgorging cash into the market. It had so much cash it paid down more in T-bills than it issued in coupons. In June it issued only $25 billion net, and over the past 4 weeks only about $35 billion.
The market can handle that. Shakily, yes, but it can absorb that without the Fed’s help.
That all ends now.
This report illustrates how we got here, estimates how it all plays out, based not on conjecture, but known facts and government issuance schedules. And I suggest what you can do about it to protect yourself and play what’s to come.
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