Author: Lee Adler

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The debt limit has been raised. The Treasury has flooded the market with supply, and will continue to do so for another month or two. But there’s been no disaster in the market. The Fed’s RRP slush fund, designed to absorb the flood of supply, has even grown, thanks to year end window dressing.

Even after that window is undressed this week, there will still be around $1.6 trillion in that fund to start. That is overnight liquid money that holders will use to buy new Treasury issuance. The RRPs will gradually be drawn down. But there’s enough there to absorb the ongoing supply bulge that the government needs to issue to rebuild its cash and repay the internal accounts it raided while the debt limit was in place.

We don’t know exactly how much more the government needs to get its internal accounts back to normal, but it could achieve that purpose very quickly given the availability of the RRP fund. It holds more than enough cash to fund that issuance.

That RRP fund, with it’s baseline starting point of approximately $1.6 trillion also gives the Fed cover to wind down QE to zero in March. The Fed will cut QE, and everything will look hunky dory. Wall Street will conclude that “tapering” QE was no big deal. Market complacency will be thick. Get out your carving knives.

Once the Fed has cut QE to zero, and RRP holders decide that they will spend no more to support the market, is that when the crisis begins?  No, not immediately.

First, there will be the annual tax windfall that occurs in March and April, when corporate and individual income taxes for the preceding year come in. The Treasury always uses that cash to temporarily pay down outstanding debt. The holders of that debt get money back. They use that cash to buy longer term paper, and in some cases to buy stocks. So we get a seasonal rally every year in March and April.

But in late May, the Treasury starts net borrowing again. Then we watch. We watch to see how that RRP fund is doing. Once it turns flat, and there’s no more QE, and the seasonal tax windfall cash has been spent, that’s when the trouble starts in the market.

Sell in May and go away? This report tells you why that might be a good idea. The report shows what to expect for both stocks and bonds, along with the why’s and wherefores, likely timing, to give you a clear grasp on on a strategy and tactics that might make sense for you.  Get the full story in the subscriber version.

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The conditions we were looking for last month have happened.

11/21/21 Whether there’s a default or not, the debt ceiling will be lifted, probably sooner rather than later. When it is, a tsunami of Treasuries will flood the market, mostly in T-bills. But there could also be a huge slug of makeup supply at the long end. That would send bond prices into the dumpster, and T-bill rates and bond yields flying.

How much chaos would the Fed bear before issuing another huge emergency round of QE? That’s the question, ultimately. But in the interim, the event that everyone would see as a positive, raising the debt limit, could be the quintessential “sell the news” trigger leading to a broad based crash in all asset classes.

This is what we need to be on the lookout for as this saga progresses. Therefore, I still don’t want to xxxxx xxxxxx xxx xxxxxxx xxx xxxx (subscriber version). From the liquidity perspective, I hate the intermediate term outlook for xxxx.

But I’m still comfortable following the trend on stocks, remaining long until the market tells us otherwise, especially if that happens around the lifting of the debt limit.

So that’s where we are. Will it? This report has the answer.

The debt ceiling was lifted yesterday, December 16, and stocks have been getting pounded for the last two days. This could be the moment we’ve all been waiting for, in terms of market action in stocks. I’ll address that in more detail in the Technical Trader reports.

Right now in the third week of the month we’re in peak QE week, as the Fed settles its MBS purchases this week. It’s the most bullish QE vs. supply imbalance we’re ever going to have. This is the end my friends. I can’t believe, but we’re on the Eve of Destruction.

That’s because the Treasury will now issue a massive amount of new supply in a very short period of time. It has a goal that calls for raising $600 billion to restore its cash account to the desired level. Plus it must raise additional funds – who knows how much – to repay other internal government accounts it raided to stay below the debt ceiling.

It means that there will be a lot of supply, A LOT, over the next couple of months.

What’s worse, the Fed is cutting its QE purchases at the same time. Talk about a Perfect Storm. Fed QE has funded more than 100% of the Treasury market in recent months. The norm since the Fed began QE in 2009 has been 85-90%. When it cuts QE to zero in March, it will still have a small amount of MBS replacement purchases, but that won’t even be a rounding error in terms of the amount of debt the market will need to fund.

The canny Fed and Treasury have, however, created a $1.6 trillion slush fund to help absorb those Treasuries. It’s the Fed’s RRP program, where money market funds, banks, and dealers can deposit the cash they got back from the T-bill paydowns that they got from the US Treasury since February. This report has the charts to show exactly how that worked. The correlation is perfect.

The Treasury paid off that paper systematically so that it would stay under the debt ceiling. That money is now just sitting there in overnight, same as cash, RRPs, waiting to re-absorb all the new Treasury supply that’s on the way.

Or is it? Nobody is forcing the money managers holding those RRP funds to rebuy Treasuries. They may like holding riskless Fed RRPs even more than they like holding Treasuries. So maybe not all of that $1.6 trillion will be available to absorb new supply. That’s where the problems start. When the RRP holders decide they’ve had enough. The slush fund won’t last forever. We’re tracking it closely and should know exactly when it is signaling a big problem.

Of course the Fed could force the issue, by ending the RRP program, but there’s still the point where that fund hits zero, and simply isn’t there to absorb new supply. At that point the market would face an intractable problem. Lots of supply and no ready cash to absorb it. We know exactly what would probably happen then, because we know the positioning of the Primary Dealers at all times.

Rates and yields would xxxxxxx xxx xxxx (subscriber version). Bonds would xx xxxxxxx (subscriber version). Dealers and banks would xxxxxxx xxx xxxx. Massive Fed intervention xxxxxxx xxx xxxxx  xxxxxx.

We should soon be able to estimate the timing of that.

For now, I really don’t foresee a way out of this. Only the timing is in question. I’m staying away from the xxxxxxx xxx xxxx (subscriber version), and looking for xxxxxxx xx xxxxxxx xxx xxxxxx xxxx.

Get the rest of the story and ideas on how to handle what’s to come  spelled out and illustrated in the subscriber version.

Subscribers, click here to download the report.

Subscription Plans

KNOW WHAT’S HAPPENING NOW, before the Street does, read Lee Adler’s Liquidity Trader risk free for 90 days!

Act on real-time reality!

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