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Category: Liquidity Trader – US Treasury Market Trend Supply and Demand

Get Ready for the Coming Bond Market Bloodbath

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Janet Yellen has now confirmed that the Treasury will run out of money in October, as we already knew from our tracking of the data.  Congress will be forced to raise the debt ceiling. Treasury supply will mushroom at the same time as the Fed begins to cut its market support operations. The RRP slush fund will affect the timing of the coming disaster. But we know its coming and we have a good idea of when.

Meanwhile the BLS has fomented a completely false picture of inflation. I explain that in this report. It’s blatant.

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

QE Still = 100% of Treasury Issuance, But Coming Change = Crash

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The Treasury is rapidly exhausting its cash as it continues to pay down T-bills. At this rate, it will run out of cash xxx xxxx xxxx xxxx (in subscriber report). Congress will then be forced to raise the debt ceiling.

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The Treasury will need to issue immense amounts of new debt to repay the internal accounts it raided, and to rebuild its cash account to the TBAC recommended level of $400 billion.

For the past month, and until the debt ceiling is lifted, Fed QE has been covering and will cover 100% of new Treasury issuance. That’s a short term bullish factor for bonds and stocks as it keeps pumping cash into the dealer and other institutional accounts that had been the holders of the T-bills being redeemed.

In fact, it’s surprising that the stock rally has been so muted, and that the bond rally has stopped in its tracks over the past 6 weeks. That’s because corporations have been rushing to issue new equity and new debt to take advantage of the high prices they can get. This is free money to them.

Once the Treasury begins to issue new debt, it will be on top of this gigantic wave of corporate supply. It won’t be pretty.

It also won’t be immediate. I estimate that by the time the debt ceiling is lifted and the Treasury supply tsunami starts, the Fed’s RRP slush fund will reach xxxx (subscribers only). That’s how much new Treasury debt can be issued before the crisis becomes apparent.

We have some time. And we have the meters of the Fed’s RRP slush fund account, and the schedule of new Treasury issuance, as well as the QE schedule. If the Fed chooses to reduce that schedule, that’s their problem, and the market’s.

But it won’t be ours. Because we’ll be actively watching, with situational awareness. We’ll be prepared to take advantage with enough advance notice to act accordingly. Here’s our current situational awareness update.

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

So You Think the Fed Can Taper?

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Treasuries have sold off on the strong, surprise jobs report last week.

At the same time, there’s been an equally important, but less well known surprise. The Treasury has maintained an increased pace of T-bill paydowns in the first third of August, despite the re-imposed debt ceiling.

That’s a short term bullish factor for bonds as it keeps pumping cash into the dealer and other institutional accounts that had been the holders of the T-bills being redeemed.

But it also means that the Treasury will spend its cash faster than I had initially imagined. That means that the bullish influence will end sooner than in my last guess.

I use the word “guess” deliberately. It’s difficult to estimate of what brilliant, but crazy, policymakers will make up when the heat is on.

The good news is that we now have evidence of a pattern. That pattern shows a fast spenddown. At this rate of spending, the Treasury will run out of cash in xxx xxxx (in subscriber report). As I recall from the past 7 debt ceiling debacles, there’s also a legal mandate that the government must make a large military pension fund contribution at the end of the fiscal year which will affect the drop dead date.

Maybe they can delay that for xxxx xxx xxxx (subscriber report) depending on the strength of mid September quarterly income tax collections. But at some point in xxxxxxx, the pressure to raise the debt ceiling will force a deal.

The jobs data was a surprise. As usual, the BLS first release is BS. The July nonfarm payrolls report grossly overstates the increase in jobs. The tax data is actual and, as I pointed out in the monthly Federal revenues report posted last week, withholding tax collections show that the payroll gains were certainly less robust than the BLS said they were.

As you may recall, back in the spring, there were a couple of months were the nonfarm payrolls gains were severely underreported relative to what the withholding tax collections were showing. I wrote then that the BLS data would catch up to the reality within a few months. I believe that the July report was the “catchup” month.

In our report on July federal withholding collections, we saw a dip in the second half of the month that suggested that the economy had fallen off a cliff. But withholding has now recovered to the trend in force since mid May (CHART in subscriber report). It is now at an inflection point where it should signal whether the economy has gotten back on track, or is in the process of rolling over. This should happen over the remainder of this month. I’ll post an updated chart when it happens.

The Wall Street talking head community, with a few Fedheads chiming in, is now in a growing chorus that the Fed will start tapering soon. Our analysis has been that the Fed can only taper if the Federal deficit is shrinking, thereby reducing Treasury supply. If the Fed were to taper in the face of constant or rising supply, the market would need to adjust in order to absorb the additional supply. Bond prices would fall and yields would rise.

This is where the revenue trend is important. If it weakens, the deficit will grow and supply will increase. This is even before considering the $1 trillion infrastructure spending package. If revenue growth stays strong, the Fed could conceivably do a small cut in QE (aka taper) without crushing the bond market. That could turn into the muddle through scenario.

The Treasury market rally of recent months has meant that Primary Dealers have built a profit cushion that would provide some protection in the event of bond market price weakness. In addition, initially, the supply increase that results from the lifting of the debt ceiling will be funded by the trillion + dollars that has been deposited in the Fed’s RRP program. That is still growing as the Treasury continues to pay down T-bills.

Those two factors will delay a bond market crisis for xxx xxxx (subscriber report).

It depends on when the debt ceiling is lifted, how much tax revenue the US economy is generating, and how much the Fed cuts its purchases of Treasuries and MBS as it begins the “taper.”

A muddle through scenario is always possible, but a crisis is also possible, if not more likely. The timing is in question, but it should come xxx xxxx xxxx xxxx (in subscriber report). The timing will become clearer as the trends of the data begin to show themselves once the debt ceiling is lifted. That includes the supply schedule, the trend of Federal revenue, and the Fed’s schedule of reduced purchases.

In the meantime, the status quo rules. As long as the Treasury is using its cash to pay down t-bills, the uptrend in stocks should continue. The selloff in Treasuries over the past week should reverse as those paydowns continue.

See the full report for the charts, more details on the supporting data and how we arrive at these conclusions, along with the timing, and an idea of the appropriate strategy under these conditions.

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The Search for The Primary Dealer Holy Grail

The Fed publishes a huge pile of data on the dealers’ holdings, transactions, and financing each week. It’s organized in a way that’s completely useless for our purposes. It’s granular to the nth degree, not aggregated as we need it to be.

Over the past couple of weeks I’ve thought about how to aggregate the data in a way that would make sense, and perhaps tell us something.

I managed to make some sense of it. It’s not the holy grail that I was hoping for, but it’s interesting. And again, it shows just how insanely leveraged the system is. The Fed simply can’t allow a selloff in the bond market. It would be catastrophic.

Here’s the chart that shows why. There’s a lot we can learn from it about just how much danger we face.

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The Big Dealer Leverage Brainfart

Sometimes the mouth goes faster than the brain.

I chat with Lindsay Williams on his Strictly Business Podcast, once every couple of months. When I spoke with him on Thanksgiving Day I said something that I immediately realized was wrong. I said that there’s no way to know how leveraged the Primary Dealers are in their bond portfolios.

Of course, that’s wrong. The New York Fed publishes enough data every week for us to figure it out. So I set to figuring.

The question is how to put that data together in a meaningful way. There’s a lot of it, and a lot of figuring, rumination, trial, and error to be done. This is just the first installment.

What I can show so far is not earth shaking. We already knew intuitively that the dealers are leveraged to the hilt, and therefore in grave danger if bond prices fall below a certain level. We don’t know exactly what that level is, but at some point, soon I think, they’re going to face calls from their unindicted co-conspirators for more collateral.

It’s 2 PM. Do you know where your margin man is? You know. The guy with the tire iron.

So below is the first chart that I painted with the data. It shows the level of dealer net Treasury repo borrowings versus their total Treasury holdings. Surprise, surprise! They correlate!

I’ve been reporting to you their total repo borrowings before this. Those totals have been in the $1.75 trillion range, which is about 8 times their total Treasury holdings. That would be like you having a $3 million mortgage on your $400,000 home. OK. It doesn’t work.

They’re not just borrowing to support their Treasury inventories. They’re also banks. They lend. Most of that borrowing is to finance their lending activities. So I ran their reverse repo operations, where they take in securities as collateral for lending cash to degenerate gamblers like me and you, but mostly the big hedge fund wiseguys in Greenwich, Palm Beach, and the Upper East Side.

Netting that lending activity out leaves us with their net cash borrowings, which should in theory bear some relationship to their Treasury holdings.

Not that their loan sharking activities are without risk. But this is the big boy, in my opinion—the net leverage on their Treasury collateral. It’s like your margin account, except it’s not 50% margin. It’s more like 75% to 200%.

Since the Fed took over the bond market in September 2019, buying approximately 85% of all new Treasury issuance, on average, the ratio of dealer net borrowings to their Treasury holdings has stayed pretty close to 100%.

Why isn’t that a problem? Because, Praise the Load, Jaysus of the Church of the Fed is backstopping them. But despite the fact that He has been relieving them of some of that inventory since May, the dealers keep increasing their leverage.

This report includes that chart, along with what it tells us about present conditions, what to expect in the near future, and what we should do about that.

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TBAC Magic 8 Ball Cloudy

In the second month of each calendar quarter the US Treasury gets together with a shadowy group called the TBAC, which stands for Treasury Borrowing Committee of the Securities Industry and Financial Markets Association.

The Treasury tells the TBAC how much money it will need to borrow to pay its bills for the rest of the current quarter and the subsequent quarter. The TBAC tells the Treasury how to schedule it. In other words, it sets out the type of issuance and the timing for the rest of the quarter and the next one.

In case you’re wondering, here are the current TBAC members. They change from time to time.

I just note that the Vice Chair is good old Brian Sack, who ran the NY Fed trading desk for several years. He was the guy who was in charge of executing the Fed’s trades with Primary Dealers in implementing QE. Now he’s making the big bucks on Wall Street as a “global eConomist.”

How would you like to be the firm that snagged him and his insider connections at the Fed? I wonder what that cost them.

But I digress.

The TBAC’s quarterly borrowing schedules are central to us because they tell us the schedule of expected new Treasury debt issuance (supply), months in advance. In the good old days, before pandemics and debt ceiling crises, that was extremely useful information to have because the Treasury rarely digressed from the TBAC schedule.

That has changed during the last couple years of the Trump Regime, because the mechanism for being able to reasonably forecast the Treasury’s borrowing needs broke down. First, they broke down because the Regime wanted to manipulate Congress by using the Federal Budget as a cudgel. Then things got worse when the pandemic came.

Last week the TBAC issued its revised estimates for the current quarter, and its first stab at Q1 2021.

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Dealer Dementia, Payback Delayed but Not Denied

I’ve marveled at the ability of the players to keep stock prices rising despite the reduction of Fed QE, and the continued pounding of Treasury supply on the market. Even more amazing is the fact that the rally in stocks has NOT come at the expense of the Treasury market. The Treasury market has managed not to blow up.

“How are they doing it?” I have wondered. And WTF does it mean for the future?

I have some answers, but not all. Obviously, as much as I’d like to get there for your benefit, I have never come remotely close to finding all the answers. Fortunately, I just need enough of the right ones to get the direction of the market right. Right now is a particularly difficult time for that. The Fed is barely absorbing 20% of new Treasury issuance and bond prices stay high and stock prices keep going higher?

My thinking has been that, no, you’re not wrong, Lee, the market is overstretched and vulnerable.

How can this be happening? Simple. The dealers and other big market participants are again piling on more leverage. They’re making the same mistake they always make right before everything blows up. The shock is how quickly they forget the lessons of recent history. Short term memory loss I guess. It’s dementia. That’s it. The dealers have dementia.

So here we are. Yet again, those who do not remember the past are condemned to repeat it. Here’s why, and what to do about it.

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We Knew the Treasury Paydowns Would Be Bullish, But What Now?

Last month in the Treasury Supply update (May 16) I wrote that the debt ceiling would continue to force the Treasury to pay down debt, short term T-bills in particular. I said that the paydowns “will continue until the end of Q2. That’s bullish for bonds, and possibly for stocks.”

But then I said that the picture changes radically in Q3. And that has not changed. Here’s what’s happened so far, what’s likely for the third quarter, and then the big change that’s coming. Having this information will help you to continue to take advantage of the market’s big move, and to be ready for when and how it’s likely to change.

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Federal Budget Data is a Bad News-Bad News Story

Tax collections were strong in May except for a dip that coincided with the Nonfarm Payrolls survey. Here’s why that’s unequivocally bad news for the markets and why you need to get ready for a delayed shock reaction.

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Get this report right now and read Lee Adler’s Liquidity Trader risk free for 90 days! Satisfaction guaranteed or your money back.  New subscribers can join by 5:00 PM Pacific Time Friday, June 14 and get the first month free! Free first month, and 90 day risk free trial offer is for first time subscribers only. Quarterly billing will begin on the 31st day unless you cancel before that date.

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