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Category: 1 – Liquidity Trader

Reports on the Fed and Treasury, Primary Dealers, real time Federal tax collections, foreign central banks, US banking system, European banking system, and other factors that affect market liquidity. Resulting market strategy recommendations. 7-8 reports each month. Click here to subscribe. 90 day risk free trial!

Market Dough Gets Punched Down

Surprise, surprise! They pumped the money in but the market didn’t rise.

The Fed has been in the process of pumping $88 billion into Primary Dealer accounts this week in the form of its regular monthly MBS purchase settlements. Most of it is done. $22.7 billion of it will settle on Monday September 21. That will be the last MBS settlement until October 14-21.

Meanwhile, the Fed continues to purchase and settle Treasuries virtually every day. Over the past week that’s amounted to a total of about $37 billion. That means that a total of $103 billion in QE settled this week. That’s how much cash the Fed pumped into Primary Dealer accounts.

It didn’t matter. The stock market sucked gas. Bonds treaded water. It sure looks as though the Fed has somehow managed to magically peg bond yields just below 0.80% on the 10 year. The Treasury issued $104 billion in new coupon paper over the past week and that didn’t depress the market? It’s a miracle.

But isn’t it strange that the amount of QE and the amount of Treasury coupon issuance was virtually the same.

Uh… No.

But some other stuff sure as heck is, and you need to know about it.

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Why No More Pandemic Spending Is Bullish

The economic rebound from the depths of the pandemic panic in April and May has ended. The economy may be rolling over again. Bad news for workers and consumers, but not necessarily for investors.

The US Government did no pandemic relief spending in August, and none is on the immediate horizon. Despite that, the monthly budget deficits are freaking enormous and frightening.

Tax receipts are weak and they will provide no relief from those deficits. The US Treasury will continue to borrow massive amounts of money in the markets.

Sounds like bad news for the stock market, right?

Eh, not quite.  Here’s why.

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Mr. Minus-chin Conspires With QE for September Happy Ending

Well…

The selloff that we expected as a result of the scheduled month end liquidity shortage happened.

Just one problem.

It came a week later than expected. Unfortunately, in a business where timing is everything, that matters. When the selloff didn’t happen right away, I stopped expecting it. Ooops. Apparently we need to build into our forecasts an allowance for a one week lag between money injections and market reactions.

So this week, the market had a little Wile E. Coyote moment, looked down, and plunged. But suddenly yesterday, it sprang back to life.

Why? The Fed didn’t step in. It is maintaining its schedule of about $18 billion per week in Treasury purchases, and a similar or slightly larger amount of MBS purchases which varies according to the amount of MBS prepaid off the Fed’s balance sheet the prior month. No change there.

As we know, those are forward contracts which only settle in the third week of the month. The September settlements start Monday, September 14. We need to watch out for that.

In the meantime, Dr. Evil’s sidekick, Mr. Minus-chin, the keeper of the US Treasury cash hoard, rode to the rescue yesterday.

Should we expect more of the same?

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August Federal Deficit Decline is Worse Than It Looks

Tax collections have leveled off at a negative year to year rate. That will allow the Fed to continue to paper things over at the current level of support it is providing. Here’s what it means for stocks and bonds, not to mention the US economy.

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Status Quo Antisellem

The Fed’s balance sheet resumed its growth in August after a bit of a stall in July when dealers paid off Fed repos. That program has been at zero since then. Dealers don’t need to borrow from the Fed when the Fed is cashing them out every week with QE.

And there’s the rub for bears. There’s still enough QE to keep this farce going, short term factors notwithstanding.

Last week was MBS settlement week (see last week’s QE update). That pumped $100 billion into dealer accounts. Not all of that showed up on the Fed’s balance sheet total assets because other assets were paid down in the. MBS get paid off in the normal course of business during the month. Some of the Fed’s superfluous alphabet soup programs have also had reductions.

But that stuff doesn’t really matter to the stock and bond markets.

Our focus is on the Fed’s securities holdings, in what’s called the System Open Market Account (SOMA). That’s where the action shows up. It’s the money that the Fed pumps into the financial markets through its straw men, the Primary Dealers. And that is still steadily growing.

Here’s what that means for the outlook and strategy.

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What If Primary Dealers Are Wrong on Their Bullish Treasury Bet?

No news isn’t no news. The Primary Dealers are in the same posture they’ve been in. They’re still bullish on bonds and that’s an extremely dangerous situation.

It’s like that warehouse packed with explosives in Beirut. One small fire could ignite a conflagration of biblical proportions.

The dealers continue to maintain historically large fixed income positions. Those positions hit record high prices. They’ve accumulated a good bit of inventory near the highs. They remain highly leveraged. Worse, they’ve reduced their futures hedges significantly. They are positioned for even more or a bullish environment in bonds.

This report gives you the keys to look for.

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