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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!

Here’s Why Front Loaded Stimulus Will Be Catastrophic for the Market

Both bonds and stocks have weakened over the past 2 weeks. It’s a sign that the Fed isn’t supplying enough QE.

We’ve known for a long time that it wasn’t enough to support twin bull moves in both asset classes. Have we reached the tipping point where it’s insufficient for either to move higher while the other descends?

The answer, my friends, is blowing in the wind—the wind of margin calls now blowing through dealer balance sheets as leveraged fixed income positions continue losing value.

Meanwhile the $2.9 trillion Biden stimulus proposal may boost the US economy, but it will be a disaster for the increasingly fragile stock and bond markets. Here’s why, and what you should do about it.

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Now That We’re Through the Month-end QE Shortage

We have a little tightness in the market at the end of every month. That’s because the Treasury issues a big wad of TP and the Fed isn’t there to absorb it. The Fed is just doing its piddly little $20 billion a week of Treasury purchases, and the Treasury is slugging the market with $100 billion or so of new supply.

Last week the actual numbers were worse. The last QE injection was $6 billion on December 23. They then didn’t do another one until Monday January 4, with $8.8 billion. Meanwhile, the Treasury plopped $164 billion in new supply on to the market on December 31.

We got through the deluge relatively unscathed. But there’s a lot to look forward to for the rest of the month.

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The Monster In the Room Is Not Make Believe

Back in September I wrote to you about why I was giving up on the banking system indicators. I’ve reposted that rant in an addendum to this report. Essentially it boils down to this. Every time there’s a critical problem in the banking system due to banker malfeasance, the Fed steps in to paper it over and reward the criminals.

That’s why we focus on the Fed more than anything else.

The banking indicators were useful once upon a time. The Fed has rendered them irrelevant. But I promised to keep an eye on them, so herein is a review. It makes me sick and should make you sick too, but we’re not here to fight the Fed. We’re here to make money by understanding and playing according to the Fed’s rules. The Fed’s first order of business is always to protect its banker clients. And it does that very well indeed.

Once again trouble is brewing, and the Fed will need to come up big again to prevent it from blowing up the banking sector. If history is any guide, the Fed will be there. It may be to the detriment of those who don’t own capital, but they don’t matter. The Fed doesn’t care about them, and refuses to take responsibility for the intractable problems that has caused our society.

Consequently, being a bear for the right reasons does not pay. To make money in these markets you must play on the side of the criminals that run the show, the Fed and its client banks.

These banking indicators help us to understand just what they’re doing, and where the landmines might be that one day could blow this whole game to smithereens.

This brings us to a recurring theme. The first sign of potential systemic blowup would be an upside breakout in the 10 year Treasury yield. It would mean that the Fed had lost control, and that the system was careening toward an abyss from which there might be no Fed response big enough to escape.

We’ll take a look at that, but also some other problems in the banking system balance sheet that the banks and the Fed are pretending don’t exist. Well, they exist and they’re bubbling up just below the surface, to burst forth one of these days in the not too distant future.

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Look Out Bears, We May Be Headed for Excess QE

The Fed continues to fund roughly 85% of new Treasury issuance. It affirmed at last week’s FOMC meeting that it won’t cut QE for the foreseeable future, and it will add, if needed. That means that if the Treasury needs to borrow more, the Fed will add more QE.

But it’s now apparent that the Treasury won’t borrow more for the foreseeable future. The new stimulus bill that we now know is about to pass will cost $900 billion. But the Treasury has $1.6 trillion in cash on hand.

This has huge implications for the stock and bond markets.

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Fed Balance Sheet Tells Bears To Float Like Butterflies, Sting Like Bees

The Fed’s policy remains stable at about $170 billion per month in QE, give or take a few billion depending on the level of MBS replacements. The balance sheet is growing on trend.  The stock market is tracking with it, as usual.

This will lead to a huge problem when the economy begins to react to enlarged stimulus.

This report discusses how to position trading strategy to take advantage.

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

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The Stimulus “Magic Bullet” Is Bearish

Withholding tax collections were relatively stable through November. But the 5 day average ticked a hair below November’s low here in early December. New lows would suggest that December’s jobs data will be awful, which will add to the likelihood of more stimulus, both fiscal and monetary. Whether that’s bullish or not depends on the Fed. The wrong fiscal/monetary balance could ignite a conflagration.

The Wall Street captured media constantly feeds us the BS that the vaccine is the Magic Bullet that will save us. But while we wait for that shot, the talk about more, more, more stimulus will continue to be the narrative that drives the pundit excuses for why the markets are doing what they’re doing. “Market Rises on Stimulus Hopes” will be the near daily headline.

This is mindless nonsense designed to divert us from paying attention to the financial markets’ real problems.

We have become inured to these $200 billion monthly budget deficits. But this data has catastrophic implications which I get into in this report.

And this is BEFORE any new stimulus.

As more and more Americans get the virus, and more people know someone who has gotten it, or worse, died, the economy sinks.

The eConomic establishment sees the vaccine as the magic bullet. But we now know that it won’t be available for widespread distribution until next summer, thanks to the Don Trump waving off a bigger, sooner deal with Pfizer.

That means that the US will be dependent on social consciousness to reduce the spread of the virus for at least the next 7 months. Good luck with that. 74 million people believe that the election was stolen, and the virus is a hoax. Consequently they refuse to wear masks and proudly engage in superspreader behavior. That won’t change after January 20. So we face months of worsening economic conditions and ever bigger deficits.

Until then, the only magic bullet is more stimulus. It may or may not cushion the catastrophe besetting many American households. And its consequences for the financial markets will only be guessable when we know the size of the package and the size and shape of the Fed’s response. We know what the Fed needs to do at a minimum, and we know what will happen if it doesn’t do it.

Here’s what to look for.

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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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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.

Subscribers, click here to download the report.`

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!

Here’s Why More QE Won’t Be Enough for the Markets

Here’s the problem. When rates are falling, there are more sales, and especially more refi. So the prepayments go up, and the Fed sees a greater reduction in its MBS holdings. Those reductions had been running at the rate of $65-70 billion per month through last month, based on the prepayment rate in the market in prior months. The Fed then bought that much from the dealers in the following months.

As always, those settlements were held in the third week of the month. The Fed would settle a total of $100-110 billion in prior forward MBS purchases that week, and the dealers would suddenly be flush with cash.

Good thing too. Because the 15th of the month is when the Treasury issues a pantload of new notes and bonds. The amount of Fed MBS purchases typically provided enough cash to the dealers for them to cover nearly all of the Treasury issuance. They could either buy it outright, or provide the repo financing to customers so that they could buy it. Then there was even some left over for them to play markup games with their equities inventories.

But mortgage rates have been rising since August. Prepayments are falling as a result. Home sales are holding up, but refis are cratering. As a result, the nearly final figure for the Fed’s MBS settlement in mid December is only $69 billion. That’s $30-40 billion less than in recent months.

At the same time, the TBAC says that the Treasury will issue $98 billion in new notes and bonds on December 15. The day before, the Fed’s MBS purchases will only total $52 billion.

That’s a problem. But there’s an even bigger problem next week. And an even bigger problem after that when the US Government passes new stimulus. Here’s why, and what to do about it.

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