Category: Fed, Central Bank and Banking Macro Liquidity

We have finally seen the effects of the bond market crisis in dealer inventories, and it isn’t pretty.

Dealer inventories have plunged by $166.6 billion since February 24. This is not simply repricing of the inventory. This is active, aggressive liquidation. We have reason to believe that it is forced liquidation. We know that because we know the degree to which this inventory was bought and carried with insane levels of leverage.

One chart in the report shows the scale of the drop, and relates it to the direction of Treasury securities prices.

Another shows total dealer Treasury collateral repo versus the yield on the 10 year note on an inverted scale. That shows the direction of Treasury prices relative to their total repo borrowings against their Treasury holdings.

Another chart shows all Primary Dealer net borrowings, which is the net of their repo and other financing from their reverse repo and margin lending operations. That’s plotted versus their total Treasury holdings. This chart is interesting because it shows the total amount of leverage employed against the only the safest collateral held.

Then there’s the mother of all charts. The chart shows a four year history of the direction of Treasury prices, overlaid with total dealer fixed income positions, and net dealer borrowings used to finance those positions. At the bottom is the ratio of the net debt financing to the total fixed income portfolio value.

The correlation between all 4 series is clear. The past is prologue. The implications are horrifying.

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FREE REPORT – Proof of How QE Works – Fed to Primary Dealers, to Markets, To Money

On February 23, the US Treasury pumped $55 billion in cash into the accounts of Primary Dealers, banks, money market funds, and other institutions who had held the T-bills that were expiring that day. These redemptions began the US Treasury’s series of massive, twice weekly paydowns of the US government’s short term debt.

The purpose of the paydowns was twofold. First, the Treasury is required by the current budget law to whittle down its cash from a peak of $1.8 trillion last year, to $133 billion by August.  Treasury Minister Janet opted to start the process by paying down existing short term debt.

That accomplished the second goal, which was to force holders of the expiring paper to buy longer term debt. Despite their protestations that all is well, economic policy makers know that the crash in Treasury note and bond prices is causing a crisis in the Primary Dealer system.

Minister Janet works very closely with Lord Jaysus of the Fed, of course. They expected that the T-bill paydowns would help to reverse the decline in the prices of Treasury notes and bonds by forcing cash into the accounts of dealers and investors. It didn’t work. At least not to the extent that they needed. The full report is reserved for subscribers. 

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What else is new?

Tomorrow, the Fed talks. But Fed talk is cheap. The Fed wants you to think that talk – its talk – moves the markets, or keeps them stable. That’s just utter bull. You and I know that from simply tracking the data for as many years as we have. Bottom line, as always, is, money talks, and the Fed’s BS is just that.

All of the discussion and paralysis by analysis in the media is a sideshow. Mass confusion that consistently misses the point. It all boils down to one simple fact. When the Fed pumps money into the financial markets via the Primary Dealers, stock prices follow the money. Everything else that happens in the economy is tangential and irrelevant to trading.

I started tracking and charting the data that goes into this in 2002, courtesy of the NY Fed print shop. Here’s the chart that started it all. It was made famous in 2012 when Rick Santelli featured it in one of his rants on CNBC.

Many, many people have copied this in the years since I began publishing it about 17 years ago. But they all fail one basic test. Here’s what it is and why it matters. It matters so much that it could mean that the end of the financial system as we know it is at hand.

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The bear market in Treasuries that started in August devolved into an outright crash last week. Meanwhile, evidence shows that cash in Primary Dealer accounts has exploded to the highest level in history, with the biggest weekly increase in history. There’s also circumstantial evidence that that cash came directly from US Treasury, away from the publicly visible means that we already saw last week.

We are not surprised there’s a crisis. You and I have been watching the situation deteriorate for months. My first guess was that the trouble would start when the 10 year yield crossed 0.8%, That was premature. It was just a preliminary. Then I guessed it would be 1%. Sure enough, within a few weeks after crossing that level, things deteriorated rapidly into last week’s climax.

While the Fed sat on its hands, saying, “Nothing to see here, all is well,” the US Treasury sent in the cavalry. As I covered in the bulletins I sent you over the past week, the Treasury has announced $160 billion in T-bill paydowns. These put cash directly into the accounts of those who hold the expiring bills. This includes dealers, banks, and big investment firms of all types.

Two of those paydowns, totaling $96 billion settled on February 23 and 25. The Treasury, no doubt working with the Fed, absolutely wants the crash in bond prices to reverse. They know damn well that the stability of the system is at stake here. I believe that we have passed the point of no return. They must get Treasury prices back up, or else.

The Treasury will almost certainly continue these cash injections. They still have plenty of money left to do it. It is still sitting on $1.38 trillion in cash.

But oddly, dealer cash accounts rose by more, and Treasury cash fell by more, than what we can account for with these paydowns, and the other things we know about. Here’s the evidence, the implications of it, and a strategy to potentially profit from the coming crisis.

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There’s so much confusion out there about how money gets from the Fed into the stock and bond markets. I see the comments in my Twitter feed. People are clueless. Like how M1 is causal. Or how the Fed pumps money into the banking system and that doubles back somehow to speculative bubbles.

This post was originally published for Liquidity Trader subscribers last week. I am posting it here in full now for everyone. If you would like to regularly receive and support this research, please subscribe! 

The amount of ignorance out there is epic. Few people seem to have any interest in the facts about how monetary policy works- the nuts and bolts aspects. And yet, the process is direct, and much simpler than everyone realizes.

Welcome to today’s world of propaganda overload, particularly Wall Street propaganda. There’s an ocean of free “information” out there, and most of it is worth what it costs.

So, let’s talk about the confusion around QE cause and effect, with financial bubbles and money supply. And let’s get to the point — the proof of how QE actually enters the banking system AFTER it gets pumped into the markets, not before.