Category: Fed, Central Bank and Banking Macro Liquidity

The market has the benefit of $115 billion in Fed mid-month QE MBS purchase settlements this week. That would normally be very bullish.

It’s notable that the market has not done more with it. And why not? Still massive Treasury supply along with surging corporate debt and equity issuance is absorbing most QE. There’s not enough left to power an endless bull trend in stocks.

That has been our thesis for the past month or few, and the market seems to be bearing that out. Stocks are stuck in a broad trading range and bonds are weakening.

$83 billion of the MBS settled last Thursday. That helped put $82 billion in Treasury coupon issuance to bed the next day. Whodathunk that the Fed would pump into dealer accounts almost the exact amount that the market needed to absorb the Treasury issuance!

Amazing how that works.

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Normally this much QE every month would be wildly bullish. But the supply of financial assets has risen to meet the demand driven by QE. We’ve reached stasis – equilibrium, so to speak.

But it is fragile. Bonds are teetering on the brink of an abyss. If they go over, and bond prices fall (yields rise), the system would collapse without another round of massive Fed intervention.

So we need to pay attention. Do bonds go over the cliff? How long would it take the Fed to react if they do? And will it be enough, yet again?

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We have known for a couple of months that there would be a mountain of Treasury supply hitting the market at the end of September. We also knew that Fed QE would be far from adequate to absorb this supply. So I have expected something bearish for stocks at the end of September. This could spill over into the first week of October.

But then things get hairy for bears, with potentially happy days for bulls. Unfortunately, we have a little problem this week. There’s no visibility. We don’t know what they have planned for the next couple weeks. That’s different from usual, where we can usually see ahead for a week or two because we know the Fed’s QE schedule, and also pretty much know how much Treasury supply to expect.

Now, thanks to the exigencies of the past pandemiconomic US Treasury fund raising back in March and April, we don’t have that luxury on Treasury supply, which forces us to surmise some things.

Here they are.

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Surprise, surprise! They pumped the money in but the market didn’t rise.

The Fed has been in the process of pumping $88 billion into Primary Dealer accounts this week in the form of its regular monthly MBS purchase settlements. Most of it is done. $22.7 billion of it will settle on Monday September 21. That will be the last MBS settlement until October 14-21.

Meanwhile, the Fed continues to purchase and settle Treasuries virtually every day. Over the past week that’s amounted to a total of about $37 billion. That means that a total of $103 billion in QE settled this week. That’s how much cash the Fed pumped into Primary Dealer accounts.

It didn’t matter. The stock market sucked gas. Bonds treaded water. It sure looks as though the Fed has somehow managed to magically peg bond yields just below 0.80% on the 10 year. The Treasury issued $104 billion in new coupon paper over the past week and that didn’t depress the market? It’s a miracle.

But isn’t it strange that the amount of QE and the amount of Treasury coupon issuance was virtually the same.

Uh… No.

But some other stuff sure as heck is, and you need to know about it.

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After years of following and reporting certain banking indicators for hints about how liquidity is impacting the system, and vice versa, that’s the question I’m now asking myself.

Well, there is an answer. And you need to know it! For your financial health, and for your sanity.

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The Fed’s balance sheet resumed its growth in August after a bit of a stall in July when dealers paid off Fed repos. That program has been at zero since then. Dealers don’t need to borrow from the Fed when the Fed is cashing them out every week with QE.

And there’s the rub for bears. There’s still enough QE to keep this farce going, short term factors notwithstanding.

Last week was MBS settlement week (see last week’s QE update). That pumped $100 billion into dealer accounts. Not all of that showed up on the Fed’s balance sheet total assets because other assets were paid down in the. MBS get paid off in the normal course of business during the month. Some of the Fed’s superfluous alphabet soup programs have also had reductions.

But that stuff doesn’t really matter to the stock and bond markets.

Our focus is on the Fed’s securities holdings, in what’s called the System Open Market Account (SOMA). That’s where the action shows up. It’s the money that the Fed pumps into the financial markets through its straw men, the Primary Dealers. And that is still steadily growing.

Here’s what that means for the outlook and strategy.

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