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The conditions we were looking for last month have happened.

11/21/21 Whether there’s a default or not, the debt ceiling will be lifted, probably sooner rather than later. When it is, a tsunami of Treasuries will flood the market, mostly in T-bills. But there could also be a huge slug of makeup supply at the long end. That would send bond prices into the dumpster, and T-bill rates and bond yields flying.

How much chaos would the Fed bear before issuing another huge emergency round of QE? That’s the question, ultimately. But in the interim, the event that everyone would see as a positive, raising the debt limit, could be the quintessential “sell the news” trigger leading to a broad based crash in all asset classes.

This is what we need to be on the lookout for as this saga progresses. Therefore, I still don’t want to xxxxx xxxxxx xxx xxxxxxx xxx xxxx (subscriber version). From the liquidity perspective, I hate the intermediate term outlook for xxxx.

But I’m still comfortable following the trend on stocks, remaining long until the market tells us otherwise, especially if that happens around the lifting of the debt limit.

So that’s where we are. Will it? This report has the answer.

The debt ceiling was lifted yesterday, December 16, and stocks have been getting pounded for the last two days. This could be the moment we’ve all been waiting for, in terms of market action in stocks. I’ll address that in more detail in the Technical Trader reports.

Right now in the third week of the month we’re in peak QE week, as the Fed settles its MBS purchases this week. It’s the most bullish QE vs. supply imbalance we’re ever going to have. This is the end my friends. I can’t believe, but we’re on the Eve of Destruction.

That’s because the Treasury will now issue a massive amount of new supply in a very short period of time. It has a goal that calls for raising $600 billion to restore its cash account to the desired level. Plus it must raise additional funds – who knows how much – to repay other internal government accounts it raided to stay below the debt ceiling.

It means that there will be a lot of supply, A LOT, over the next couple of months.

What’s worse, the Fed is cutting its QE purchases at the same time. Talk about a Perfect Storm. Fed QE has funded more than 100% of the Treasury market in recent months. The norm since the Fed began QE in 2009 has been 85-90%. When it cuts QE to zero in March, it will still have a small amount of MBS replacement purchases, but that won’t even be a rounding error in terms of the amount of debt the market will need to fund.

The canny Fed and Treasury have, however, created a $1.6 trillion slush fund to help absorb those Treasuries. It’s the Fed’s RRP program, where money market funds, banks, and dealers can deposit the cash they got back from the T-bill paydowns that they got from the US Treasury since February. This report has the charts to show exactly how that worked. The correlation is perfect.

The Treasury paid off that paper systematically so that it would stay under the debt ceiling. That money is now just sitting there in overnight, same as cash, RRPs, waiting to re-absorb all the new Treasury supply that’s on the way.

Or is it? Nobody is forcing the money managers holding those RRP funds to rebuy Treasuries. They may like holding riskless Fed RRPs even more than they like holding Treasuries. So maybe not all of that $1.6 trillion will be available to absorb new supply. That’s where the problems start. When the RRP holders decide they’ve had enough. The slush fund won’t last forever. We’re tracking it closely and should know exactly when it is signaling a big problem.

Of course the Fed could force the issue, by ending the RRP program, but there’s still the point where that fund hits zero, and simply isn’t there to absorb new supply. At that point the market would face an intractable problem. Lots of supply and no ready cash to absorb it. We know exactly what would probably happen then, because we know the positioning of the Primary Dealers at all times.

Rates and yields would xxxxxxx xxx xxxx (subscriber version). Bonds would xx xxxxxxx (subscriber version). Dealers and banks would xxxxxxx xxx xxxx. Massive Fed intervention xxxxxxx xxx xxxxx  xxxxxx.

We should soon be able to estimate the timing of that.

For now, I really don’t foresee a way out of this. Only the timing is in question. I’m staying away from the xxxxxxx xxx xxxx (subscriber version), and looking for xxxxxxx xx xxxxxxx xxx xxxxxx xxxx.

Get the rest of the story and ideas on how to handle what’s to come  spelled out and illustrated in the subscriber version.

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

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In the financial markets, money talks. I have observed and reported for many years that talking about a change in monetary policy, announcing that change, and actually executing it, are entirely different matters. The market tends not to anticipate change, it responds to actual changes in liquidity.

While the Fed and the mouthpieces of the mob have talked about tightening policy for months, the Fed only announced that it will finally tighten policy this month. The policy has yet to begin. That changes next week.

The new policy implementation begins now. The Fed actually will reduce its QE purchases for the first time since September 2019. That’s when the Fed undertook its emergency “Not QE” policy in response to the money markets freezing up. That came about from a Fed policy of non-intervention after Powell ended Yellen’s balance sheet normalization in December 2018. From December 2018 until September 2019, the Fed stood by while an onslaught of Treasury supply crushed the money markets.

The new policy that begins now is a tightening because it will reduce QE purchases. Anything that isn’t the status quo purchase rate of a total of $200 billion or so a month including MBS replacements, is effectively a tightening. The Fed will be buying less paper each month.

And so, the actual effects of the new policy begin now. The Fed will reduce its Treasury purchases by $10 billion for the mid November- mid December period. It will cut MBS purchases by $5 billion. It will continue to roll over maturing Treasury holdings and prepaid MBS. The net effect will be a reduction of $15 billion in the first month, and then $15 billion the following month.

They said they’d be flexible. In other words, if the markets tank, they’ll be back with more QE. The idea that they’ll continue cutting purchases for the 7 months it would take to get to zero, is a pipe dream. But it’s possible that they could cut for at least xxx-xxx months (subscriber version) before running into problems big enough to stop them.

I wrote months ago that the Fed could only reduce QE if the Treasury cuts issuance. That’s on the schedule this month, particularly as the new debt ceiling again restricts issuance.

But reduced issuance isn’t no issuance. After the dust settles and the debt ceiling is finally lifted or suspended for the long haul, the US Treasury will still be issuing an average of $150 billion per month in net new debt. If the Fed cuts QE for two months to new purchases of $90 billion per month after two months, and MBS replacement purchases average another $50 billion or so, the Fed will still be taking down directly or financing indirectly 93% of new issuance. No problem there. The market could sail right along with that.

But higher bond yields mean higher mortgage rates. Higher mortgage rates mean fewer refinances and fewer MBS prepayments. We don’t know exactly how much. But it will be an exacerbating factor. At the peak of the refi boom, Fed MBS purchases totaled $120-130 billion per month. Now they’re down to $100-110 billion per month, and they will drop more as mortgage rates rise.

If the stock market remains relatively stable going into January, the Fed will continue to cut its total outright purchases of Treasuries and MBS. They’ll go to $75 billion in January, and $60 billion in February. At that point, let’s say MBS replacements drop to around $40 billion a month. Then total Fed purchases would be around $115 billion and Treasury issuance would still be $150 billion. Then we’re talking about 77% of new issuance.

The benchmark for the Fed for the past dozen years has been to directly absorb and indirectly fund a total of  xx% (subscriber version) of new issuance. The only time they went lower for any length of time was during the Yellen balance sheet bloodletting from October 2017 to December 2018. That did not go well. Once the 10 year breached 3%, the panic was on. Powell took over, panicked, reversed course, and began QE to infinity and beyond.

Now we’re going to find out again how far they can push the “tapering” fantasy. They told the market that they’re going to be “flexible.” Which means that they’ll reverse course at the first sign of trouble.

The issue is where that will be. First benchmark to watch on the 10 year is txxxx xxxx xxxx xxxx (subscriber version). If that’s cleared, and I have little doubt that it will be, the pressure will be on.

The Fed’s media mouthpieces will start floating the trial balloons around then. But remember! Guidance schmidance. Money talks, and BS, even Fed BS, walks. Once the pressure on the markets begins to manifest itself, the market won’t reverse course just because of a few words from the Fed. The market will only reverse when the money starts to flow again.

As Johnnie Cochrane famously said, “The Fed must pump, or the market will dump.”

With that in mind, we look at the macro liquidity chart (subscriber version) to this point and see that nothing has changed. Stock prices continue to track with rising liquidity. But that rise is about to slow, and month after month for the next xxx-xxx months (subscriber version) months at least, the Fed will tighten the screws. My guess is that around xxxxxxxx (subscriber version), we should start to see negative impacts in the financial markets. Treasuries will come under pressure first. Stocks will follow.

Be ready for things to change. The Fed is tightening. Rule Number One now points in the other direction for the first time since the Yellen bloodletting of 2017-18.

All spelled out and illustrated in the subscriber version.

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