Author: Lee Adler

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Withholding Tax collections remained strong in January. A sharp drop in the year to year change was due to an increase in the base of comparison a year ago, and is not a sign of economic weakening. At least not yet.

Withholding collections should be at or near the trough of their usual 2-3 month cycle. So the ADP private payrolls collapse notwithstanding, and regardless of what the BLS says this morning, jobs growth is not decelerating. At least not yet.

But even if the economy is strong and the market must only absorb $80 billion per month of expected new supply versus the $$150 billion -$200 billion per month of the past couple of years, $80 billion is still more than enough to disrupt the markets if the Fed isn’t buying.

Here’s why (subscriber version).

We know that the Fed was usually absorbing or funding about 85-90% of total supply, leaving the market to absorb the rest. That was enough to suppress the 10 year yield at or below 1.3%. At the time, new issuance was averaging around $200 billion per month. So the market was only absorbing $20-30 billion per month, outright. The Fed was buying or funding the rest.

When the debt ceiling was reimposed last year, supply was restricted, but the Fed maintained QE at the same pace. That meant that it was funding more than 100% of supply for a couple of months. That excess cash was sloshing around in Primary Dealer accounts. They put it to use by accumulating, marking up, and distributing stocks to a fevered customer base of institutions, hedge funds, and small traders. That caused the meltup in stock prices.

The arithmetic on Treasury supply versus market demand tells us that the average supply of $80 billion per month is more than the maximum of $30 billion per month that buyers were absorbing directly while holding bond prices stable. In other words, $30 billion in supply was what the market could bear without prices falling and yields rising. The Fed subsidized the rest.

Hence, without Fed buying,we should expect  …. (subscriber version).

And that’s with an expanding economy and growing tax revenues. If the economy contracts on the heels of market dislocations, that will only exacerbate the situation.

In order to absorb the Treasury supply, dealers, investors, and traders must either take on more debt, or liquidate some of their existing holdings, whether Treasuries or stocks. I suspect, based on the evidence of the past two months, that …. (subscriber version). For that reason, I’m focused on selecting swing trade chart picks on  …. (subscriber version). in the Technical Trader weekly reports.

I’ll keep you updated on the developments and outlook. Get the full story in the subscriber version.

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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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Correction: In paragraph 4 I have corrected the line about the dealers’ net position to “net long.” In the original version I inadvertently wrote “net short.” That was an error. Sorry for the confusion! 

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The Fed provides us with a tremendous amount of information and data. Some of it is highly useful. Most is not, from my perspective of trying to figure out how it will influence, or even to some extent control, market direction.

One area of useful information is the data that the New York Fed publishes every week with a 9 day lag on Primary Dealer positions and financing. The dealers run the markets, after all, so it’s good to have some insight into their positioning and leverage. It can, at times, give us a heads up that trouble may be brewing. We saw that over the past year as the dealers began to reduce their massive, and massively leveraged, fixed income portfolios.

I have pointed out that that was a huge problem, because a decline in bond prices could put them under water again, just as during the pandemic panic of March 2020. The problem was so big then that the even more massive Fed bailout looked as though it wasn’t working for about 8 days. Then it did work, and the market turned. But it was a close call.

In recent months we saw the decline in the dealers bond positions, but they were still net long and still leveraged. I warned that as bond prices fell and yields rose, their profits would be pressured, and if it continued, their capital could be wiped out again.

The dealers are really just hollow shells acting as strawmen for the Fed, buying Treasuries from the US government, and MBS from Fannie and Freddie and the FHA on the Fed’s behalf. Meanwhile they play side games accumulating, marking up, and marketing all manner of other assets, particularly stocks.

But now the Fed is getting out of the buying business. No more backstopping the dealers with constant massive funding. Meanwhile, the dealers are still REQUIRED, by virtue of their status as Primary Dealers, to still buy Treasuries.

How exactly will they be able to do that without steadily being cashed out by the Fed to the tune of a hundred and some billion per month, month in and month out?

The Fed will probably tell us tomorrow that it’s going to zero purchases after March.  The dealers must keep buying. There are only two ways they can fulfill that responsibility. They’ll either have to sell stuff first. Stuff, as in other Treasuries, other fixed income instruments, OR, drum roll please…… Stocks! Or they will need to borrow more money, that is, increase their leverage even more.

We’ve seen all of those processes in action in the past two weeks. We’ve also seen them report lower than expected profits. Why? Because they’re getting their asses kicked on those massively leveraged net long positions in fixed income.

And the Fed thinks that it can just withdraw from supporting the market with its massive money printing operations to buy virtually all of the debt the US government issues? Well as I told you before, oh, you can’t do that!

This little demonstration we’ve gotten over the past two weeks is just a taste of what’s to come until the market again forces the Fed to reverse course. We don’t know where or when that will be, so for now we just rely on Rules Number One and Number Two.

1. Don’t fight the Fed. and,
2. The trend is your friend aka, don’t fight the tape

Bounces in both the bond and stock notwithstanding, the Fed’s policy is clear, and the trend is clear.

In the last version of this Primary Dealer update in December I wrote, “At the very least, we need to be prepared for a sharp selloff in stocks, and what should turn into a resumption of the bear market in Treasuries.” 

Nailed it.

Find out what to expect now and what we’re doing about it in this report.

Subscribers, click here to download the 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!

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