Category: Fed, Central Bank and Banking Macro Liquidity

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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As you may know, I recently moved to Nice, France, purchased an apartment, and began renovations. I’m living and working in a construction site, and personally managing the renovation. I’m having a blast, but it’s not without its challenges, particularly on leaving enough time to fulfill my obligation to you to get these reports out to you on a timely basis. I’m a little late this week, and I ask your forbearance in this process.

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This undertaking being in France means that those doing the work here will disappear for the month of August. I’ll “relax” by getting these reports out to you on a more regular schedule, at least until the second phase of my reno gets going in September. Everything should be done by the end of September. Then I won’t have any more excuses for late postings. I can’t use strolling the Promenade des Anglais, or Nice’s Old Town just two blocks from here, as an excuse (Non subscribers, click here to read this report).

If you have never been to the South of France, or even if you have, I encourage you to visit. It’s an amazing part of the world. The options for things to do around here are endless, whether it’s beaches, outdoor activities, sightseeing, or culture and food. The last two in particular. It’s France, after all (Non subscribers, click here to read this report).

Fall is gorgeous here, with daytime highs in the low to mid seventies through October, and the mid to high sixties in November. And it is sunny almost every day. If you would like to come, and have questions, drop me a note. Of course, we’ll meet for a cup of coffee, or a drink, or a meal on one of the hundreds of terrace restaurants all over this city. There are thousands of outdoor cafes and restaurants for you to enjoy all around the region, with the some of the world’s best sightseeing (Non subscribers, click here to read this report).

Now on with the show. This is the Primary Dealer update, which I last did in mid June. First, I’ll replay the summary from the last report, then update you on the details through this week. Non subscribers, click here to read this report.

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. It’s likely to xxxx xxx xxxx xxxx (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 xxxxxx xxx xxxxxx xxxxx. (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.

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. Let’s just accelerate the time frame for when I expect the market to begin experiencing tighter liquidity from xxxxxxx xxxxxxxxx, to the xxxxxxxxx x xxx xxxxxx. We need to be on the lookout for signs of reversal in the bond rally xxxxxx xxxxxxx  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).

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We’ve been in a bad bear market in stocks for over 6 months. And a really bad bear market in bonds for almost two years. It could have been worse. Why hasn’t it been? Because even though the Fed hasn’t been absorbing any Treasury supply, supply has been so light that stock and bond prices have reached an  equilibrium range. It’s been volatile. It’s been unsteady. But it hasn’t collapsed.

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In June, the Fed began actually withdrawing cash from the banking system at the rate of $47.5 billion per month. They call it QT, or Quantitative Tightening. $30 billion of that is in Treasuries, and $17.5 billion is in MBS. They plan to double those amounts in September. I’m doubtful they’ll even get through August, but we’ll see.

Reason number one that the end of QE and beginning of QT has not triggered a collapse is that these withdrawals are not simply the opposite of QE. QE was injected into the financial markets directly through the conduit of bond purchases from Primary Dealers. The Fed paid for the purchases by crediting the dealers’ accounts at the Fed with new cash. The dealers than used that cash to accumulate more securities, promote and mark up those securities, and distribute them. As long as the Fed was pumping money into dealer accounts, this process pushed stock and bond prices higher.

Under QT, the withdrawals are not done in trades with Primary Dealers. The money is not sucked directly out of dealer accounts. The QT process only hits the dealers indirectly, and in reduced amounts relative to QT.

The Fed withdraws the money from the financial system by telling the Treasury to repay some of its debt to the Fed. The Treasury must raise the cash to repay the Fed through sales in the market. The buyers of the new paper pay for it by withdrawing cash from their bank accounts. The Treasury sends that cash to the Fed in repayment of the debt. And just like that, the money disappears into the Treasury Black Hole Account.

OK, I kid. It’s not a black hole, but the effect is similar. The Fed sucks the money in, and it disappears from the financial universe. Indeed, the Fed can make it reappear whenever it wants to, but for now, it’s like the South Park episode where Kyle deposits $100 in a new bank account. And it’s gone. The banking system shrinks. There’s more Treasury debt to be absorbed week in and week out, and less cash to absorb it week in and week out. Drip, drip, drip.

Only the boyz have had it good since March. Tax collections have been so enormous on the big quarterly and annual tax due dates that the US Treasury has been able to continue paying down T-bills at a rate in excess of $100 billion per month. Withholding taxes also surged in June.

The result has been that net Treasury supply of coupons less the bill paydowns has only been in the neighborhood of $30 billion over the past month. In April and May, and part of June, the Treasury was actually disgorging cash into the market. It had so much cash it paid down more in T-bills than it issued in coupons. In June it issued only $25 billion net, and over the past 4 weeks only about $35 billion.

The market can handle that. Shakily, yes, but it can absorb that without the Fed’s help.

That all ends now.

This report illustrates how we got here, estimates how it all plays out, based not on conjecture, but known facts and government issuance schedules. And I suggest what you can do about it to protect yourself and play what’s to come.

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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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