Category: Fed, Central Bank and Banking Macro Liquidity

Subcscribers click here to download the complete report.

Intro

The Fed has bought mass quantities of Treasuries and MBS over the past dozen years, in what are called Permanent Open Market Operations or POMO. This is just a fancy name for trading with Primary Dealers. We call the Fed’s massive asset purchases Quantitative Easing, or QE. The Fed buys that paper strictly from Primary Dealers with rare exceptions. The dealers then use the cash to buy more paper, whether more Treasuries, MBS, stocks, or other financial instruments.

QE has become the primary source of demand for absorbing the supply of financial assets. The primary source of supply is the US Treasury which has lately been issuing an average of $200 billion per month, or more, of Treasury debt. The market must absorb that. In the absence of QE, prices would be under constant downward pressure. Since stocks and bonds are to some extent interchangeable financial assets, both asset classes would be affected.

The Fed has made sure to print enough money, that is to pump enough cash into the accounts of Primary Dealers, to ensure that prices maintain a steady upward course. The Fed has made sure to engineer QE to all but guarantee bull markets in stocks and bonds.

At some point that could change, and we watch the data carefully in order to estimate when that’s likely to happen.

The QE vs. Supply Equation

QE has thus become the primary fuel that powers demand for financial assets.

The flow of QE cash to the Primary Dealers is almost steady, with a non-material reduction in MBS purchase settlements scheduled for mid month.  Meanwhile, Treasury supply, to this point has been steadily enormous, fluctuating within a semi predictable range month to month. Not much has changed since the Fed’s pandemic emergency phase of QE began in March of 2020.

Until now. The big change is that the Federal debt ceiling is now back in force, which means that Treasury issuance will first slow, and possibly stop, until Congress raises the debt limit. This will reduce new Treasury issuance. Supply will be constricted. The reduction in supply could give the bond market rally a second wind, or it could accrue to stocks, or both.

So it will be bullish for awhile. Then it will stop. Then we’ll have a Wile E. Coyote moment. And then it will end. Badly. Here’s the how, why, and the timing.

Subcscribers click here to download the complete report.

Subscription Plans

We’ve been following the story of the US Treasury paying down outstanding T-bills since late February. $680 billion of paydowns led to a big turnaround and rally in longer term Treasuries as the Treasury pumped that money into the accounts of former bill holders and simultaneously removed that paper from the market. Some holders sought greener pastures in longer term paper, leading to the rally in the 10 year yield and other maturities.

In recent weeks we’ve taken note of the Treasury reducing those paydowns, and we saw a few hiccups on the Treasury market. But over the past week, the rally resumed, thanks to this being the Fed’s monthly MBS purchase settlement week. Then the Treasury piled on again on Thursday, announcing another $48 billion in bill paydowns for this week.

The Fed holds MBS settlements in the third week of every month, for forward purchase contracts it made over the past two months. This week’s settlements total $128 billion, which is yooge. They started last Wednesday (July 14) with a down payment of $83 billion. The second installment is for $15 billion today. They finish up on Wednesday, injecting another $29 billion into the accounts of the Primary Dealers from whom they buy that paper.

Then late last week, the Treasury announced, in its infinite wisdom, that it would pay down another $40 billion in T-bills tomorrow (July 20) and $8 billion on Thursday. Drowning in cash, enough fixed income guys turned blue and bought further out on the curve on Friday and this morning to send bond prices soaring and yields crashing.

Apparently the dealers and others have wanted nothing to do with stocks, so they ploughed all of the cash into Treasuries. The stock selloff exacerbated the yield rally, and vice versa.

Traders and pundits tend to talk rotation when these events occur. For now, they’re blaming a resurgence of COVID cases, which is unwarranted because with a majority of US and European citizens at least partially vaccinated, few people are dying. It’s just mindless panic.

But here’s where Treasuries are really headed, and why. And what you should do about it.

Click here to download the complete report.

Subscription Plans

Note: Holiday Publication Schedule- I’ll be taking a brief break from publishing over the holiday week. I expect to resume publishing on July 6. Enjoy your holidays! 

The Fed’s balance sheet continues to grow. But the often repeated figure of $120 billion per month in Fed asset purchases is inaccurate and misleading. The Fed’s balance sheet grew by $198 billion for the 4 weeks ended June 23. The Fed’s total QE purchases for the month of June were $202 billion, including the weekly Treasury purchases, and all the forward MBS purchase contracts that settle in the third week of the month.

I wanted to get this report out before the holiday weekend, and my planned travels over the next two weeks. I’ve been planning the trip and at the same time packing up for my exit from Croatia after residing in this wonderful country for the past 18 months. I apologize for this report being perhaps more disjointed and incoherent than usual. Hopefully, the ideas I want to communicate are clear enough.

The Fed’s balance sheet continues to grow. But the often repeated figure of $120 billion per month in Fed asset purchases is inaccurate and misleading. The Fed’s balance sheet grew by $198 billion for the 4 weeks ended June 23. The Fed’s total QE purchases for the month of June were $202 billion, including the weekly Treasury purchases, and all the forward MBS purchase contracts that settle in the third week of the month.

Other Wall Street observers don’t count everything. They ignore the Fed’s MBS purchases bought to replace those MBS holdings that were prepaid because borrowers paid off their balance either by sale or refinance.

That money comes out sale or refinancing proceeds of individual mortgage borrowers. It has no impact on the financial markets. To replace those prepaid MBS, the Fed buys more MBS from Primary Dealers. The cash the Fed pays to replace those prepaid MBS goes right into the accounts of the dealers. It makes absolutely no difference why the Fed bought the paper. It doesn’t matter if it’s new paper or rollover paper. All $202 billion went into Primary Dealer accounts. Not $120 billion.

Another factor boosting the markets lately is the Treasury’s T-bill paydowns, which I’ve been reporting for you regularly. They totaled $133 billion in June, coming out of the Treasury account on the Fed’s balance, sheet, and mostly going into RRPs. You would think that the markets would have done even better with all this cash flooding in. But most of the paid off T-bills were held by money market funds. They’re not going to put that cash into longer term Treasuries or stocks. They had no place to put the cash, so they sent it off to the Fed for safekeeping, in the Fed’s RRP program, while they wait for T-bill issuance to pick up again.

That will happen, but the question is the timing. The debt ceiling is the wildcard.

This report examines what it means for the stock and bond markets, particularly when we can expect bullish to turn bearish. Click here to download the complete report.

Subscription Plans

Stock prices are currently right in the middle of the channel surrounding the liquidity line in the Compositite Liquidity Chart (viewable in subscriber version). By this measure the market isn’t overbought, as so many bearish pundits are bellowing. Nor is it oversold. It’s just tracking the growth of systemic liquidity. Not too hot, not too cold, but just right. Goldilocks.

Subscription Plans