Category: Fed, Central Bank and Banking Macro Liquidity

The dealers have significantly hedged their bond longs since April, but the price damage that we expected, in both bonds, stocks, and everything else, was an inevitable result of that. To deleverage means to liquidate existing positions. Liquidate means sell. The dealers and their biggest customers have been doing just that. To build up hedges, they’ve also been selling futures, adding to the pressure.

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But unfortunately, they reduced hedges during the recent bond market selloff. The dealers are the Wrong Way Marshalls of the bond market.

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This market selling pressure comes as no surprise to us. The forces of this spiral have been building for the past two years, first as Treasury supply overwhelmed the market beginning in August 2020, and then subsequently, as the Fed moved to tighten policy.  The dealers have never been properly positioned for this. It’s the mirror image of their massively wrong positioning in 2007 that triggered the 2008 crash. Non subscribers, click here to read this report.

The problem now is that their hedging may not be enough. The spiral of falling prices, collateral calls, and more liquidation has now taken on a life of its own. The technical analysis of the Treasury market says there’s more of that to come, with conventional price projections pointing to the xxx% range on the 10 year yield as the next target for the bond market. Needless to say, that should also be catastrophic for US stocks. Non subscribers, click here to read this report.

From past reports:

7/27/22 The bottom line is this. Don’t be fooled by what the media is touting as a massive rally in bonds. Yes, it looks big, and it probably has a little further to go over the next couple of weeks. But in the big picture, it’s nothing. And it’s likely to stay that way. Non subscribers, click here to read this report.

Meanwhile, the dealers have mitigated some of their risk, but they and their big bank parents remain at great risk if bond prices start declining again. That should happen as liquidity begins to tighten again in the second half of August. Non subscribers, click here to read this report.

The bond rally should have a bit further to go, but I’d be a seller on the first technical signs that the trend is turning. And when bond yields start to rise again, and bond prices start falling again, I’d expect stocks to suffer from the same adverse liquidity factors that would be pulling the bond market down.  Non subscribers, click here to read this report.

LATE BULLETIN! HOLY COW, as I was proofreading this report, I just checked the Treasury issuance schedule for this week, and the Treasury will issue $40 billion in new T-bills on Monday. That will upset the apple cart, but at this point I won’t rewrite this entire report. Let’s just accelerate the time frame for when I expect the market to begin experiencing tighter liquidity from mid-month, to the beginning of August. We need to be on the lookout for signs of reversal in the bond rally sooner that I originally thought. Non subscribers, click here to read this report.

But at least this news confirms my earlier forecast that the T-bill paydowns would end in July, making for tighter liquidity in conjunction with the Fed’s QT program. And lest we forget, they plan to double the amount of system withdrawals in that program beginning in September. Non subscribers, click here to read this report.

6/13/22 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. Non subscribers, click here to read this report.

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. Non subscribers, click here to read this report.

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. Non subscribers, click here to read this report.

5/14/22 That all means that a double whammy will hit the market in mid June, at a time when Primary Dealers and the banking system are already weakened by huge losses in their bond portfolios. Some of these highly leveraged dealers will be forced by their lenders or their parent bank holding companies to liquidate anything that they can to pay back the margin and repo loans that funded the purchases of all this paper. Non subscribers, click here to read this report.

There are no doubt other big leveraged players out there with massive losses that will be forced to liquidate by margin calls. The selling will not be limited to the bond market. It will hit stocks too, and anything else that isn’t tied down. Non subscribers, click here to read this report.

If this analysis is correct, the weakness that we have seen in the market over the past couple of months will be seen as but an opening act. Conditions will worsen. Stocks and bonds will decline even faster this summer. Non subscribers, click here to read this report.

Consequently, the strategic and tactical outlook remains the same. Sell all rallies. Non subscribers, click here to read this report.

4/11/22 So what would I do with this information? The same thing I’ve been doing for the past 20 months.  They’re gifts to us on the way to Dante’s Inferno.  If I owned bonds, I would sell them. If I owned stocks, I would sell them. And I would keep looking for stocks to short on the rallies. Non subscribers, click here to read this report.

I know. Cash is trash when inflation is high and interest rates are negative to inflation, but it’s less trashy than assets that are actively losing value. The strategy that I think makes the most sense in such an environment is to trade stocks from the short side. I publish the weekly swing trade chart picks for those who are looking for ideas along those lines.  https://liquiditytrader.com/index.php/category/technical-market-timing/ ….Non subscribers, click here to read this report.

The problem after that is that the Primary Dealers and the biggest banks who own them have enormous hidden losses that aren’t showing up yet on bank earnings statements or balance sheets.  As market conditions tighten in the second half of this year and margin calls beget losses, which beget more margin calls, those hidden losses will start to show up. Banks will be forced to liquidate some of their assets and will be forced to report some of those losses. Non subscribers, click here to read this report.

2/20/22The bottom line is that the financial market is moving toward a crisis. Fast. It will continue to do so as the Fed cuts QE first to zero. It will do so even more as the Fed shrinks its balance sheet by allowing maturing paper to be paid off rather than rolled over. If they do that, the pressure on on Primary Dealers will only get worse. They have not established the net short positions needed to manage it. Non subscribers, click here to read this report.

On average, their positioning is not good for a decline in bond prices (rise in yields.) Some Primary Dealers are probably well positioned. That means that some, if not most, are not. Those who are not well positioned are almost certainly already in trouble. Non subscribers, click here to read this report.

This won’t end well.Non subscribers, click here to read this report.

I’ve opined to stay away from the bond market for the past 18 months. Nothing has changed. Bond rallies are selling opportunities. The pressure on the bond market has infected the stock market, and will continue to do so. I continue to look for swing trade short selling opportunities in the Technical Trader reports. Non subscribers, click here to read this report.

1/25/22But now the Fed is getting out of the buying business. No more backstopping the dealers with constant massive funding. Meanwhile, the dealers are still REQUIRED, by virtue of their status as Primary Dealers, to still buy Treasuries. Non subscribers, click here to read this report.

How exactly will they be able to do that without steadily being cashed out by the Fed to the tune of a hundred and some billion per month, month in and month out? Non subscribers, click here to read this report.

The Fed will probably tell us tomorrow that it’s going to zero purchases after March.  The dealers must keep buying. There are only two ways they can fulfill that responsibility. They’ll either have to sell stuff first. Stuff, as in other Treasuries, other fixed income instruments, OR, drum roll please…… Stocks! Or they will need to borrow more money, that is, increase their leverage even more. Non subscribers, click here to read this report.

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What happened in the stock market on September 13 (-178 on the S&P and -1276 on the Dow), was inevitable. The timing was a complete surprise, at least to me, but sooner or later, there would have been a day like this. And I’ll go out on a limb and say that there will be more of them… until the Fed reverses course.

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Federal withholding tax collections declined in August. This was the second consecutive monthly decline after rising sharply and persistently throughout June.

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Collections steadily declined throughout the month. This is consistent with the usual 3 month pulse of the US economy, where it accelerates for the first 6-7 weeks, then slows for the second part of the period. However, the current slowdown started earlier than usual and has therefore had a longer downstroke. That downstroke is due to end now. Non-subscribers, click here for access.

Despite the slowdown, revenue growth year to year remains positive, thanks to employee earnings inflation.  From the perspective of the markets, only nominal revenue matters, not the real economic growth rate. Because revenue is a key determinant of Treasury supply. Non-subscribers, click here for access.

Nominal withholding grew xx% year over year. That would be great except that it’s a big drop from the +11.3% at the end of July. Non-subscribers, click here for access.

It suggests a rapid slowing in the US economy. But it’s only slightly weaker than the xx% gain 3 months earlier, at the end of May. As JP Morgan said, markets will fluctuate. Well, guess what! So does US economic activity. Non-subscribers, click here for access.

So is the US economy decelerating or not? With wage inflation reportedly hovering around 5-5.5%, the xx% gain in withholding tax suggests that jobs growth has xxxx xxxx xxxxx. However, this should be the trough of the normal 3 month cycle, and it is no lower than the last two troughs. While the short term cyclical breather phase is a bit more extended than usual, there’s been no breakdown from the range of the past 6 months. The economy is xxxxx xxxxx xxxxxx, not xxxxxxxxxxxx. Non-subscribers, click here for access.

Of course we never know what the BLS jobs release will show. Instead of reflecting the data collection date of the 12th of the month just completed, I’ve gotten the impression in recent months that it relates more closely to where things stood at the end of the previous month. So it’s possible that the BLS imaginary number for August will reasonably strong positive growth, reflective of July tax collections, even though we know from the tax data that the jobs market began to collapse in the second half of July and continued through August. Non-subscribers, click here for access.

The monthly average has a little over two weeks of built in lag. The 5 day average of collections is whippier, but gives us a picture of weekly action in near real time. That rolling 5 day average held above the June low, but edged slightly below the February lows twice during the month. These were not material breaks. Non-subscribers, click here for access.

On the other hand, you can see in the above chart that the trend of the 11 day total collections, which is the whippiest of all, but still subject to trends, has been xxxxxxxxxxxxx xxxxxxxxx xx xxxxxxxxx xxxx xxxx xxxx  the February-June lows. Non-subscribers, click here for access.

8/3/22 If Friday’s BLS jobs report bears any semblance of reality, the number shouldn’t differ much from the growth rate in June. But given the timing of the data collection as of July 12, and the various “adjustments” that the BLS applies to their survey data, we really never know what the first release for the month will show. They then fit their data to actual data over 7 subsequent monthly revisions and annual benchmark revisions. The first release is garbage, and hit or miss as to whether it reflects reality.

The fact of the tax data shows that so far, the much feared recession isn’t here yet.

So here we are Friday morning, a few hours before the BLS jobs data release, and as usual, I can’t predict what the BLS’s fictional artistic impression of the August jobs market will look like. The fact is that it was weak and getting weaker throughout the month. But if the number is more reflective of July, that weakness won’t show up until next month. When it does show up, whether this morning or next month, the bond market and stock market will get a short lived boost from those who expect that it will mean that the Fed will soon loosen policy. Non-subscribers, click here for access.

But the fact is that if tax revenues are weakening, Treasury supply will only increase, regardless of what Wall Street says about the economy. Treasury supply will increase due to weaker tax revenue just as the Fed requires the Treasury to add $60 billion a month in new debt sales to the public to pay off the Fed. Non-subscribers, click here for access.

In addition to that extra supply from Quantitative Tightening, and a weaker economy, Fed QT also causes demand to weaken. Not only is the Fed no longer the primary buyer and financing agent in the market, but it is also choking demand by removing the cash from the banking system that would otherwise be available to fund Treasury purchases. Non-subscribers, click here for access.

The bottom line is that the weaker tax revenues are not bullish. The accompanying weaker economic data will be spun as bullish, while in fact it will not be. At least at first. It will only be bullish when xxxxxxxx xxxxxxxxx xxxxxxxx xxxxxxxx. All I can say is, “Wait for it!” I’ll give you a heads up, right here. Non-subscribers, click here for access.

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Rule Number One is “Don’t Fight the Fed.” But Wall Street and its willing herd have done just that for the past month.  Stocks have continued to rally, and bonds have held their own, both in the face of increasingly tighter macro liquidity as the Fed whispers easy while tightening the noose.

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A big reason for the rally is that the stock market became so oversold relative to the liquidity trend in May and June. That condition warned us of the potential for a sharp rally. The market had become too stretched on the downside. It was enough to drive persistent short covering, and ultimately margin buying, as Wall Street searched frantically for excuses to buy stocks. Non-subscribers, click here for access.

Sure, the rally feels surprising and frustrating, but the warnings were there, and I posted them in the last two CLI updates in May and June. Non-subscribers, click here for access.

May 23-

…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.

…with the oversold condition comes the likelihood of vicious vertical spike rallies along the way, as overconfident short sellers load up on their positions.

…we need to be on the lookout for the start of a spike rally. If you see it, believe it.

June 28-

The previous lows were in the context of a bubble market. This is a bear market.  That doesn’t rule out a sharp rally. In fact, I think we should expect to be surprised on the upside.

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Meanwhile, the Street and its media handmaidens grasped for straws, and they found them. They found them in the “moderating” CPI report, and in the Fed meeting minutes. From these reports, they inferred that the Fed would err on the side of ease instead of constant tightening. Naturally, they misread the data and the fact that the Fed minutes are propaganda. Non-subscribers, click here for access.

So much for the narratives. The fact is that the market can only run counter to the macro liquidity trend for so long before the short covering and animal spirits that drive margin buying are exhausted. And if Wall Street is engaging in fantasy, as I think it is, then at some point, probably soon, a moment of recognition will set in. The selling will start, and the rally will reverse. Non-subscribers, click here for access.

How do we know when? That’s a matter for the technical analysis. Non-subscribers, click here for access.

The TA that I cover in the weekly Technical Trader reports has been remarkably accurate on the broad market, but less so on the individual swing trade picks, where it’s been more miss than hit in the last month. This dichotomy between the micro and macro TA is an indication of a fractured market that is not as strong the gain in the major averages suggests. There’s a lot of scurrying around as traders look for the next hot stock or the next short squeeze. A few are hitting big, while others pull back or churn in a range. That’s enough to power the broad averages higher. Non-subscribers, click here for access.

The technical projections for the market averages have pointed to xxxxxxxxxx xxxxxxxxxx xxxxxxxxx range for several weeks. They’re xxxxxxx xxxxxx xxxxxx. Non-subscribers, click here for access.

Longer intermediate swing projections point xxxxxx, but I’m skeptical. The liquidity situation is turning more bearish as the Treasury pounds the market with new supply and the Fed holds firm on QT. The Fed is set to tighten the screws even more in a couple of weeks. It announced that they will double QT to $95 billion per month in September. Non-subscribers, click here for access.

Regardless of Wall Street’s fantasies, neither the markets nor the inflation data, nor the economic data, will keep the Fed from its appointed rounds. The strength in all three will keep the Fed on track. It is likely to stay on that track until something breaks. The Fed is never proactive. It is always reactive. It drives in the rear view mirror. The Fed will only loosen after the crisis, not pre-emptively. Non-subscribers, click here for access.

On top of the Fed tightening, the US Treasury will be in the market with even more borrowing to fund the new spending program just signed into law. That borrowing will suck cash out of the financial markets and pump it into the economic stream. It sets up conditions where stronger than expected economic data could continue to surprise the economists, the Street, and the Fed. So what would be the Fed’s excuse to stop tightening? Non-subscribers, click here for access.

Furthermore, despite all the speculation that the Fed will take its foot off the brake, sticky CPI at 8.5% will hardly allow that. The idea that the end of tightening is near is wishful thinking. Especially with another surge of government spending on the way. So keep in mind that the Fed drives in the rear view mirror. The Fed will continue to remove money from the system. And the currently strong financial markets will only encourage that. Eventually that will result in a crunch, and the market will fold. Non-subscribers, click here for access.

The time to reverse course and get short for trades is coming xxxx to a trading screen near you. The TA will tell us when. In the meantime, riding the current wave xxxxxxx xxxxxxx xxxxxx. Non-subscribers, click here for access.

That’s especially true for the bond market where yields are on the razor’s edge. Wall Street has been spreading a lot of fertilizer about the 10 year yield going to 2%. But another couple of upticks in that yield now around 2.80-2.85 will xxxxx xxxxxx xx xxxxxxxx xxxxxx, and probably a xxxxxxxxxx xxxxxxxx xxxxxxxxx xxxxxxxxx xxxxxxxx. Non-subscribers, click here for access.

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We’ve had a helluva rally in stocks and bonds. The conditions were right for this rally, and we expected it. However, it was a bit bigger than I thought it would be. There was more liquidity around then even I expected. And the Street did its job of squeezing the shorts and creating a false narrative about pending recession and the end of Fed tightening to drive the rally. It was all BS, but it worked.

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It will no longer work. Liquidity will dry up like a California forest in July. The fires will start, and without liquidity to douse them, they will burn like the fires of Dante’s hell. Non-subscribers, click here for access.

The US Treasury confirmed yesterday that there will be an enormous increase in supply in August, just as I was able to previously project based on the facts and trend data we already had. Non-subscribers, click here for access.

The stock and bond rallies are not long for this earth. It’s time to watch for, and heed, the technical sell signals. Non-subscribers, click here for access.

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