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Category: Fed, Central Bank and Banking Macro Liquidity

Analysis of the major forces of macro liquidity that drive markets. Click here to subscribe. 90 day risk free trial!

Stocks Are Even More “Oversold” Versus Liquidity

The thing is, there’s no such thing as “oversold” in a bear market. OK, maybe there is, but it’s at a much lower parameter than that which applied during the 13 year bubble.

Therefore we should not expect the market to turn up from extremes similar to those of the past 12 years. And we should not expect the rebounds to be sustained. They’ll correct the extreme, and then the downtrend to new lows will resume. So, what I wrote previously, recapped below, still applies. Stock prices still look oversold, even more so than in late May when I last updated the CLI.

But the bottom line remains the same. Here’s what it is. Here’s why. And here’s what you might consider doing about it if you want to profit from what lies ahead.

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We Knew QT Would Be Devastating, But You Ain’t Seen Nothing Yet

Nothing has changed since I last updated this Fed QT report three weeks ago. I have updated all the charts and details in the body of the report.

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Short term reaction rallies, and dead cat bounces notwithstanding, the intermediate outlook, and longer term, remain bearish, pending xxx xxxxxxxx xxxxxxx xxxxxxxxx xxxxxxx. That will follow the coming crash, not precede it. Anyone holding out for that xxxxxx xxxxxxxx is likely to get crushed, battered, steamrolled, destroyed, decimated, and cooked. Non-subscribers, click here for access.

Holding and hoping is not a strategy. When Wall Street tells you not to panic, they may as well be deer frozen in the headlights of an oncoming train. Smart people don’t panic. They just calmly get the hell out of the way. Cash, despite it being depreciated by inflation, still has utility. When opportunity presents itself, you’re going to need it to take advantage.

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This report will show you in charts and clear discussion, how we got here, where we are, exactly where the markets are headed, and what you can do about it to protect your assets, and even grow your capital in the dangerous, even deadly, months ahead. Non-subscribers, click here for access.

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Dealers Assume the Position, as 75 BPs Coming Wednesday

Primary dealers have finally taken aggressive action to mitigate the losses in their bond portfolios. But it is too late. The damage is done, and the pressure will only get worse as the Fed pulls money out of the banking system and forces the Treasury to borrow even more money to pay off the Fed.

In everything we look at in the Primary Dealer positions and related data we see only stress and more stress. This is unfolding exactly as we expected. There are no secrets here. We knew all this was coming simply by watching the data and Fed policy as we have month in and month out. It only proves again and again, Rule Number One. Don’t fight the Fed.

Shockingly, the Dealers seem not to have followed the Rule, and now they’re screwed, and so is the world of investors. For those who can’t sell short, there are no good options. No pun intended.

Meanwhile, the Fed will need to raise its Fake Funds rate by 75 BP this week to keep up with the market. It’s already there as liquidity conditions tighten rapidly and dramatically.

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The US Economy, Including Jobs, Collapsed in May

Federal tax collections plunged in May, withholding taxes in particular. Those worried about a slowing economy now have real data to back them up. In fact, the consensus of worried economists isn’t worried enough. That consensus is for a gain of 328,000 jobs, versus 428,000 in April. But regardless of what the BLS’s, seasonally adjusted, randomized, and otherwise statistically tortured non farm payrolls report shows, the reality is much worse.

That reality is tax collections—actual hard data, in real time, and not statistically massaged. And they were down. Big time.

This means that, if reported accurately, subsequent economic data reports will be weak. They should show economic contraction. So the economy is contracting but inflation isn’t yet. Bad combination. But it’s not enough to give the Fed an excuse to reverse policy.

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The Fed typically isn’t quick enough on the trigger to respond to economic trend changes, and it has not yet shown any propensity to rescue the financial markets in this cycle.

I’ve warned about this before. Eventually weakening financial markets would trigger economic weakening. These two facets of the monetary coin are tied at the hip. Central bank tightening triggers visible effects first in the financial markets. But nearly concurrent effects, or at most slightly lagging, occur in economic activity. They’re just not as visible and as obvious at first. Mostly because economic data lags. But also because the initial economic changes are more subtle than the more visible changes in stock and bond prices and yields.

Furthermore, government agency statistical manipulation of the data adds a random element that often creates the misimpression that the economy is doing better or worse than it is. We don’t have that problem with the tax data. It is what it is.

Now we have the first real, hard data that shows that the economy is in fact weakening, along with the financial markets. But we have yet to see any evidence that inflation is coming down.

The Fed is now in that Catch 22 phase that we knew had to come. And because of the fraudulent way that the Federal Government economic reporting agencies report inflation, the popular inflation gauges will lag as inflation moderates.

The Fed will follow the reported data, so it will be slow to respond to disinflation, when it comes, just as it was slow to respond to inflation, even after it was obvious. The Fed just refused to believe. It will likely be equally disbelieving in accepting the first signs of disinflation.

So the adverse monetary conditions are likely to persist until after financial markets have passed the point of no return. Don’t pin your hopes on economic weakness to rescue the markets. Stay focused on monetary policy, and on liquidity. This report show exactly what the real data is telling us. It shows the impact of that, the implications for the trends of stock and bond prices, and it gives you clear analysis about what to do about it to protect, and even grow your capital under these conditions.

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Quantitative Tightening is Here, and the Effect Will Be Devastating

At its May meeting, the Fed announced the beginning of its program to shrink its balance sheet. That program is colloquially known as QT or Quantitative Tightening. It will begin with reductions of $30 billion per month in its Treasury holdings, and $17.5 billion per month in its MBS holdings. That will last through August. Then in September it plans to go to $60 billion per month in reductions of Treasuries, and $35 billion in reductions of MBS.

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For comparison, under Janet Yellen’s attempt to shrink the Fed’s balance sheet in 2017-2019, the peak monthly reduction was $30 billion per month in Treasuries, and $20 billion in MBS.
That resulted in plenty of havoc in the markets, and Powell was forced to abandon the process in 2019.

This new attempt is a big deal, because through this program, the Fed will actually pull money out of the banking system at a time when the system is already under duress. Inflation is raging, and bond prices have been plummeting, and yields surging, for 22 months. Banks have hidden losses on their books from that. Those losses will start to be recognized as the Fed puts additional pressure on the system.

Stocks have also been cratering. Financial markets are likely to become even weaker than we have already seen as the Fed embarks on this additional level of tightening. As stock and leveraged bond portfolios decline in value, there will be margin calls. And that will exacerbate the situation.

Not only will the Fed now not be the biggest buyer of Treasuries in the market, it will force the US Treasury to issue even more supply. By demanding that the Treasury repay a portion of the money that the Fed lent it via its purchases of Treasury securities, the Fed will force the Treasury to sell more debt to the public to raise the cash to repay the Fed. That cash will then be extinguished. It will leave the banking system and be gone. Poof. Just like that.

At the same time the Treasury will continue to need cash to fund its regular outlays.

Recently, the TBAC (Treasury Borrowing Advisory Committee) has raised its forecast for tax revenue and lowered its estimate of Treasury supply. As usual with economic forecasts, they are backward looking and ignore current, actual conditions. The booming tax revenue trend that we saw beginning over a year ago is already showing signs of weakness in the economic component that is hidden by the inflation component. If revenues are not up to expectations, Treasury supply will increase beyond the modest levels that the TBAC expects. But even those levels are sufficient to pressure the markets.

The money to repay the Treasury’s debt to the Fed will have to come from somewhere, and that somewhere will be investors, banks, and dealers. They’ll need to liquidate other securities, and other assets of all kinds.

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This report will show you in charts and clear discussion, how we got here, where we are, exactly where the markets are headed, and what you can do about it to protect your assets, and even grow your capital in the dangerous, even deadly, months ahead. Non-subscribers, click here for access.

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Stocks Are Ahead of the Curve

The gradual flattening of the CLI is now visible. Starting in June, it should turn negative. The Fed will begin literally removing cash from the banking system and the markets in June, when it starts shrinking its balance sheet. That will have ripple effects in at least 3, if not all 4, or the components of the CLI.

In the meantime, however, stock prices have gotten ahead of the curve. They are now oversold versus the historical norms of the liquidity band over the past 13 years. Does it matter? Or is this a new paradigm?

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No question it’s a new paradigm. The Fed has ended, for the foreseeable future, its previous 12 year campaign of aggressively adding money to the financial markets in its program of inflating asset prices.

It had a trial run of this policy once before from October 2017 to December 2018, but stocks were bubbling then and the ECB and BoJ were still printing massively. That help from the rest of the world kept US markets liquified, resulting in a series of overbought readings that lasted 22 months.

The market cracked a bit in the middle of that tightening experiment, and finally fell apart when Covid 19 came around. The Fed then panicked and opened the QE floodgates. Now, we’re reaping the whirlwind from that.

As the Fed persists in tightening, in its fight against CPI inflation, my thought is that if the market can stay overbought versus liquidity for most of 22 months, it can stay oversold against it for just as long. However, with the oversold condition comes the likelihood of vicious vertical spike rallies along the way, as overconfident short sellers load up on their positions.

When they do, and the market starts to rally, they’ll spontaneously combust, driving inexplicably big advances in stock prices. Wall Street will come up with all kinds of recovery narratives to justify those rallies, but they will merely be, as Joe Granville called them, of the genre, “The Rally that Fools the Majority.” I’d make that plural, because of the probability that there will be more than one of those before this bear market is finished.

This report lays out in graphs and clear analysis, just what you should expect in the weeks and month ahead, along with how I’m approaching both the short term tactical aspects, and the longer term strategic approach for both stocks and bonds.

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Dealer Positions Show It’s Not Getting Better and It Should Get Worse

The conditions for a rally in bonds were there, only the will was missing. That finally showed up last week. Meanwhile, the dealers finally meaningfully increased their short positions in Treasury futures. Voila! There were enough shorts, and enough short covering, to trigger a rally upon the reappointment of the Chairman of the Fed Moral Hazard Bubble, Jerome Powell.

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Of course, any hopes on which this rally are based, are ill placed. Those hopes will not come to fruition. The Fed is hellbent on continuing to tighten, as it must, to meet its mandate to control consumer inflation. It is a long, long way from meeting that mandate.  It’s a long way from engineering any rescues of its bank clients and market fronting strawmen, the Primary Dealers.

Meanwhile the parent companies of the dealers, the big banks, have hundreds of billions of dollars of losses buried in their bond holdings. These are in their long term portfolios, which are not marked to market.

As the Fed begins actually withdrawing cash from the banking system via its “Quantitative Tightening” or QT program, some of these holdings with losses will need to be liquidated. Depending on how the banks structure their bond inventory accounting we may or may not see those losses. But whether we see them or not, they’ll be there, and they will place further strain on the banking system, pressuring the banks to deleverage by selling assets.

That includes their Primary Dealer subsidiaries, who have been reducing, and will likely continue to reduce, their bond inventories. Those inventories have already collapsed, both from selling and from mark to market losses, which are required for dealers.

While this has been going on, there’s been another factor which should have played an ameliorating role. It hasn’t. And we now know that it won’t.

As a result, after a brief respite, market conditions will soon get worse. Here’s why, along with how it will play out, and what to do about it.

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April Tax Collections Still Running Red Hot Mean That Fed Must Get Tighter

Federal tax collections were once again extremely strong in April, including withholding taxes, and individual non-withheld income taxes in particular. In fact there were strong gains in all types of taxes.

This means that, if reported accurately, subsequent economic data reports will be very strong. The weak Q1 GDP was an artifact of a slowdown in February. That was reversed in March, and they added on in April.

You may think that this strong economic data is good news for the markets. But it’s not. A red hot economy will continue to feed raging inflation. The Fed xxxxx xxxxxxxx xxx xxxxxx xxxxx tightening policy.

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The markets will get a brief respite thanks to seasonal Treasury paydowns but after that, the tightening monetary conditions should have xxxxxxxxxx xxxx. Non-subscribers, click here for access.

The Treasury just posted its quarterly refunding requirement for the balance of this quarter and for Q3. New Treasury supply will fall sharply. That surprised some Fintwit “experts.”

That’s something that we knew would happen and even predicted here in these reports, simply because we follow the Federal tax collection trend in real time. This isn’t rocket science. It’s published real time data. Track it and whack it. That’s what we do. And it gives us an edge.

One analyst went so far as to predict that because of this “surprise” supply reduction, this is the bottom. Well, it’s not a surprise. And its not the bottom. Primary Dealers and other members of the TBAC- the Treasury Borrowing Advisory Committee, all knew this was coming. AND YET, they still sold bonds.

It’s simply the law of supply and demand at work. The market can’t handle the truth. And never ending supply in excess of demand is a fact. Any excess of supply over demand is a problem. Even massively reduced supply, when the Fed isn’t standing in the middle of the pit taking all of it, leaving only a pittance for the market to absorb on its own.

The fact is that bond yields were only stable at low levels when the Fed was directly buying or indirectly funding more than 90% of net new issuance. Whenever the Fed reduced that percentage, bond prices fell and bond yields rose.

Janet Yellen gave us a demonstration in the 2017-2019 attempt at “normalizing” the Fed’s balance sheet, bless her heart. Powell shit his pants when the 10 year went over 3%. But then he wasn’t dealing with 8% headline inflation prints, which doesn’t include housing inflation running 20%. They suppress that. Now that he’s dealing with this inflation monster he’s crapping himself again, but this time he’s forced to tighten instead of easing, which is his more natural response.

So, since March, the Fed has essentially left the Fed Puts building. It’s still buying MBS, but not enough to keep the bond market price needle from collapsing and the yield needle from soaring.

Price and yield are the meters of supply and demand in the markets. They tell us what’s happening in the Treasury market trading pits. The direction of price is the direction of the relationship between supply and demand.

The Fed has left the trading pits, leaving the markets in the pits. And soon, perhaps as soon as the next week or two, the Fed will actually force the Treasury to increase the amount of supply it offers to the public. The Treasury will have to do that in order to pay back the Fed, when the Fed starts redeeming up to $60 billion per month of its maturing holdings of Treasuries, and another $35 billion of MBS that someone in the market will also have to buy in the vacuum left behind by the Fed.

With no help from the Fed, and despite sharply reduced Treasury supply, fixed income prices have been crashing. The Fed is about to begin piling on to that trend. So forget about the fact that tax revenues are soaring and Treasury supply is shrinking. It’s not shrinking enough to xxxxxxxx xxxxxxxxx xxx xx xxxxxxxxxxx xxxx xxxxxx xx xxxxxxxxx. Non-subscribers, click here for access.

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The bottom line is still: XXX all rallies. That goes for both bonds and stocks.

Late Addition- As I was preparing to post this, the TBAC issued its supply forecast. Yes they’re cutting issuance, but there will still be net new coupon supply of $153 billion May 16-31. And $171 billion June 15-30. https://home.treasury.gov/system/files/221/TBACRecommendedFinancingTableQ22022-05042022.pdf In Q3 they see net new coupon supply of $335 billion. The paydowns will all be in T-bills, as they have been. This will have no impact on the outlook as we have been seeing it. https://home.treasury.gov/system/files/221/TBACRecommendedFinancingTableQ32022-05042022.pdf

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The Fed is Tightening Into a Sheet Storm

Ending QE has created the perfect storm in the markets. Our warnings about the bond market going to hell and leading the stock market have been coming to fruition.

The Law of Supply and Demand is still the law of market land. The US Treasury is still issuing supply, but the Fed is no longer providing demand nor stimulating it. The Fed has gone from the biggest buyer in the marketplace to being absent by design, thanks to the raging consumer price inflation that the Fed itself created.

Now the Fed is likely to announce that not only will it not be the biggest buyer in the market, it will force the US Treasury to issue even more supply. By demanding that the Treasury repay a portion of the money that the Fed lent it via the Fed’s purchases of Treasury securities, it will force the Treasury to sell more debt to the public to raise the cash to repay the Fed. That cash will then be extinguished. It will leave the banking system and be gone. Poof. Just like that. That will further weaken demand.

But the Treasury will keep needing more cash. It will have to come from somewhere, and that somewhere will be the liquidation of other Treasury securities, stocks, and other assets of all kinds. Commercial real estate is being decimated. You think home prices are safe? Think again. What about commodities? Not yet, but that’s coming. Once the downward spiral starts, nothing will be immune.

Here’s how it will play out, along with what you can do about it to protect yourself and even profit.

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Tons of Cash, Not In Use, Signals this Huge Change in the Market

The Treasury Borrowing Advisory Committee (TBAC) told us in early February that it estimated that the US Treasury would pay down $358 billion in T-bills in the second quarter. That’s a lot of cash to stuff into the accounts of money market funds, banks, Primary Dealers, and other investors who use T-bills as a near-cash holding.

There’s nothing unusual about that. It’s an annual occurrence. The Treasury gets a tax windfall in March and April and uses the money to temporarily pay down outstanding T-bills. Those paydowns stuff cash into the accounts of those holding the expiring bills that are being redeemed. Then those former holders of the bills must find a place to reinvest that cash.

There are fewer T-bills in the market for them to roll into. When the Treasury pays them off, they’re gone. Poof. The Treasury will only start issuing new T-bill supply in a couple months when it needs to start borrowing short term again to fund government spending. Meanwhile, there’s a surfeit of cash in the accounts of money funds, banks, dealers, and investors.

Some recipients of the paydowns buy bills in the secondary market. That pushes the rate down. Some roll out a bit on the yield curve toward longer maturities. That normally pushes short term coupon paper, such as the two year note, prices upward, and yields lower. That buying ripples out through all maturities along the curve.

And a few at the margin decide to park the cash in stocks, which pushes stock prices up.

As a result of that process, we invariably saw rallies around the time of annual tax collections. Likewise, in the third week of every month, the Fed added to the cash tsunami with its regular settlement of its previous forward MBS purchases under QE. Because there’s a built in lag in that process, even though outright QE has ended, there was still a big Fed MBS settlement last week totaling $98 billion.

All told, there has been a helluva lot of cash pumped into the market in the past couple of weeks. But the markets have not rallied as I have expected them too.

Apparently, I missed something important. It’s obvious, but I underweighted the fact in my thinking. Here’s what it is, why it’s a huge deal, and what it tells us about how to trade and invest to protect, and even grow, our capital.

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