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The Fed poured $132 billion of QE into the accounts of Primary Dealers between October 14 and 21, the regular monthly MBS settlement week. As a result, we got the usual predictable result of a rally in stocks.

But there was only a weak, late holding action in Treasuries. They sold off for most of the week. That’s understandable, considering that the US Treasury sucked $218 billion out of the market that week after the debt ceiling was lifted.

It will pull another $196 billion out this week. At this rate, they’ll hit the new debt limit by xxxxx xxxxxxxxxx (subscriber version). Then the extraordinary measures game and the political/fiscal brinksmanship will begin anew.

At the same time, the Fed will begin cutting its outright QE purchases, and MBS replacement purchases will also decline because of higher rates and few mortgage refis, and thus prepayments. That would normally be very bearish, but remember! They have a slush fund! The Fed’s RRP account, which currently still holds about $1.4 trillion in cash ready to absorb the flood of new T-bills.

In the context of all this new supply pounding the financial market, the stock market rally was pretty remarkable. Stocks rose despite the fact that there was more Treasury supply than there was QE. True, there’s still plenty of cash sitting in the Fed’s RRP slush fund. As I’ve pointed out, this will cushion and help to absorb the supply hit coming from the US Treasury.

Think of the RRP slush fund as a big pot of beans simmering on the money manager cowboy camp fire. Fed QE adds more beans to the pot. The US Treasury keeps eating mass quantities of the beans. It constantly refills its plate, consumes the beans, and passes the gas into the US economy. It can continue to consume those beans until they’re gone, as in when the RRP fund is exhausted. That will happen in some months, especially as the Fed gradually stops adding beans to the pot (tapering QE).

Or maybe not that long. Maybe some of those money managers tending the pot will at some point will be like Mr. Taggert. In response to the Treasury asking for still more beans, they’ll say “I think you’ve had enough!”

That’s when both the stock and bond markets will get really interesting for bears. Of course in my view, the bond market is already plenty “interesting,” and has been for some time.

Media reports have pointed out that professional money managers are overwhelmingly bearish on bonds, as if that’s some kind of contrarian bullish omen. I hate to be a party pooper, but market consensus is often right for long periods, especially when the facts support it. In this case, the facts support the consensus. So I’m xxxxxxxx xxxxxxx xxx xxxxxxx (subscriber version). Treasuries. I wouldn’t want to hold long term debt in this environment.

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Visibility into the near future has been pretty good lately, so I’ll start with a review of what we expected, where we are now, and any changes likely ahead.

9/29/21 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 big increase in Treasury issuance.

They didn’t quite get to the zero Treasury balance. The widespread predictions of disaster by the “experts” proved too much for the politicians to bear, for them to allow a test of  zero Treasury cash.

But they only kicked the can to December by raising the debt limit by $480 billion. That’s only supposed to last until December 3, according to news reports. So we’re not finished here. We’re going to go through this exercise again in about 7 weeks.

Meanwhile, we are getting a preview of the expected increase in Treasury issuance. $110 billion in new T-bills will be issued next week. Then $109 billion in new coupon paper is tentatively scheduled for the end of the month.

I’m still expecting the Fed’s RRP slush fund to cushion the blow of that new supply. It is the ready cash that should fund the absorption of the new paper. But we really don’t know what the big money managers will do. This is Brave New World stuff. What if the money market funds decide they like the Fed’s paper just as much as the US Treasury’s? If even a few of them sit tight with RRPs instead of buying the newly issued T-bills, we could start to see xxxxxxxxxxxx xxxxxxxxxx xxxxxxxxxxx (subscribers’ version). I’d expect that to show up first in xxxxxxxxx xxxxxxx  on T-bill rates.

Again, we won’t know until we see the first new T-bill settlement on Monday, and see how much comes out of the Fed’s RRP fund.

9/29/19 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.

This did not happen. Yet. All they did was reset the clock. They have time to avoid a crisis, but will they? No doubt the news will be misleading until the deal is done. Forget about what they say. It could cause us to anticipate and act on a scenario that won’t come to pass. Watch what they do when the rubber hits the road. We’ll have time to react if we’re paying attention.

9/29/21 The Fed’s RRP slush fund is now nearly $1.5 trillion. That will fund the new supply tsunami for a few 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 dislocation in the markets will be in place. The bitter fruit of QE, and tapering QE, will be tasted.

The timing of that is uncertain. It depends largely on how fast the Treasury wants to replenish the funds it drew down or raided to avoid the debt ceiling.  

All of the above remains true, as they’ve only pushed back the Drop Dead Date.

This month, Fed 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 China Evergrand situation plays a role in generating margin calls that trigger liquidation pressures in other assets held by holders of Evergrand paper. That includes especially, highly liquid US assets.

Another factor pressuring prices is record corporate debt and equity issuance.

That’s partly on the money. There’s still an excess of QE over new supply. That will go back to a normal or below normal coverage ratio in the weeks ahead. We should start to see xxxxxxx xxxxxxxx (subscribers’ version) for stock and bond prices when that happens, especially with the increase in Treasury supply, and double especially if the Fed actually, really, no kidding, begins to taper QE in December.

There’s a lot more in this report on what to expect, including charts showing how we got here, and why we’re going where we’re going. I also post my idea on what would be a good way to deal with it successfully (subscribers’ version).

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