Category: Fed, Central Bank and Banking Macro Liquidity

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 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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After a disastrous couple of months in the bond market, conditions are now set up for x xxxxxx  there. Treasury bill paydowns will be enormous over the next month. No one expects this, because the market has been so horrible, and the Fed is so tight and will soon get even tighter. But the markets will be xxxx xx xxx from these Treasury paydowns. They’ve already started, and they will surge to enormous levels over the next 2-3 weeks.

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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 xxx xxxx. If I owned stocks, I would xxxx xxxx. And I would keep looking for stocks to xxxx on the xxxxxx.

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 xxxx side. I publish the weekly swing trade chart picks for those who are looking for ideas along those lines.

Meanwhile, the Primary Dealers are STILL positioned wrong. They’ll get this little rally in the short run to help salve their wounds. But I stress – short run.

Dare I say, “Sell in May and go away?” But make that the xxxx xx xxxx. The Treasury paydowns should continue lubricating the market well xxxx xxxx xxxx.

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.

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This report shows the imbalance of Fed liquidity driven demand and the coming short term liquidity boost from seasonal Treasury paydowns. However,  I’ve added something to this report that makes clear just how dangerous this market is.

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Banking data shows us the growing fragility of the system. Given that fragility, any seasonal liquidity driven rally in stocks and bonds will be a gift to those who have been holding and hoping. It will be yet another chance to get out. This report lays out the timing of that liquidity surge, and the likely impact on the markets. Non-subscribers, click here for access.  

The rally has already begun in the stock market. It could see a bit of a shake over the next week or so, but with massive Treasury paydowns on the way, I don’t expect the rally to be derailed yet. So I’m willing to give my buy side swing trade picks featured in the Technical Trader more running room here. They’re doing well. I expect that to continue.

Of course, bonds haven’t rallied in the past couple of months. Instead, they’ve crashed yet again. But the conditions will be ripe for a reaction rally in the Treasury market and related fixed income markets starting next month. This report lays out the likely timing and yield parameters of the next move in bonds. If I owned any bonds, here’s what I would do.

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FREE REPORT – Proof of How QE Worked – Fed to Primary Dealers, to Markets, To Money will help you understand why going in reverse will be a disaster.

The last time we looked at the Composite Liquidity Indicator (CLI), 4 months ago, I warned that the process of flattening the indicator was beginning, and that that would lead to bad things happening. Those bad things have been under way for a couple of months, but they have barely scratched the surface of the potential of what’s to come as this line turns flat. See chart (subscriber version).

The stock market is approaching the low side of its normal band of motion from the CLI. If history is any guide, the stock market will remain vulnerable to further severe declines until a week or two after the line representing the S&P 500 penetrates the bottom of the normal range of motion from the liquidity line.

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Then we face the prospect that liquidity could be even tighter than during the period of October 2017 to September 2019 when the Yellen Fed was temporarily “normalizing” its balance sheet. See chart (subscriber version).  The Fed is again threatening to begin shrinking the balance sheet. But this time around the market must absorb a far higher amount of new Treasury supply than it did in 2017-19, when the Fed last tightened.

Shrinking the Fed’s balance sheet now would pull cash out of the banking system, causing deposits to at least turn flat, if not shrink outright. I would have to bet that the Fed will never get to that point. The effects of merely holding QE at zero will be bad enough.

As for the War in Ukraine, it’s not helping, but stocks were already down nearly 9% the day that Putin attacked. Furthermore, historically, periods of war have been bullish for stocks. That’s because central banks have typically printed reams of money during wartime. Today, the Fed doesn’t have that luxury, with the  CPI headline print almost 8%, and actual inflation at least 13%.

Wars don’t drive asset price trends. Central bank policy drives asset prices. Today, central banks simply cannot be easy during this wartime because of the devastating inflation already under way.

Under these conditions, where systemic liquidity stays flat, at best, my bet would be that we will see cataclysmic selloffs in stocks at times. Violent rallies will follow, but will inevitably result in lower highs.

Led by the Fed, the world’s biggest central banks have painted themselves, and us, into a corner. They can no longer continue to tilt the playing field in favor of the continuation of a long-running secular bubble. The consequences would simply be too dire.

On the other hand, there will be equally terrible consequences for maintaining tight policy. And I’m not talking about how much they raise interest rates. That’s a sideshow that is an effect of tight money. The market will tell the Fed what to announce about rates. It must simply rubber stamp the market, lest the public realize that the Fed doesn’t control rates the way that it wants the public to think that it does.

Now the Fed is not printing enough money to absorb virtually all new Treasury issuance, with additional cash left over to support stock prices. If it sticks to this new policy of no QE, money rates will rise. Bond prices will fall and yields rise, margin calls will go out. Stock prices will fall. More margin calls will go out. And so on.

But only when consumer prices start to fall will the Fed be able to resume QE. By then, asset prices should be much lower than they are today. Therefore, I will continue to focus on looking for good short to intermediate term stock xxxx xxxxx (subscriber version).. I would continue to xxxx xxxxx (subscriber version). the bond market xxxx xxxxx.

Even bondholders who hold to maturity will get robbed. Inflation will eat them alive.

Will gold be a long term hedge for all of it? In theory, it should be, but we all know about the difference between theory and practice. Meanwhile, the long term charts of gold and some gold mining stocks look more bullish.

I’ll continue to use technical analysis in the Gold Trader reports to try to identify when this gold bull breakout is overdone. And I’ll continue to look for good entry points for getting long the mining stocks.

Meanwhile, none of this has come as a surprise. We were forewarned.

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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!

FREE REPORT – Proof of How QE Worked – Fed to Primary Dealers, to Markets, To Money will help you understand why going in reverse will be a disaster.