As the Fed has cut back on QE, Primary Dealers have also cut back their inventories of Treasuries and the leverage that they use to finance them. That’s not bullish. Here are the details and a few charts along with a suggested strategy to play the dealers’ game, not the one they want you to play as they set up new traders for the kill.
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The imbalance between Fed QE and Treasury supply is ugly as as it gets for the next week, but then it gets less ugly. Here’s what you need to know and how you need to see it to trade successfully.
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We know that total liquidity is still growing. The Fed is still printing and pumping money into the system at an historic rate. That rate is well above the norms of the original QE back in 2009-10, but well below the peak panic levels of March and April. The Fed has been dialing it back from the extreme pumping it reached at the market bottom in March.
Ay, but theres’s a rub, and it’s not barbecue. It’s an irritant. And the markets won’t like it.
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Primary dealers have been gradually paying down their outstanding repo loans from the Fed, just as we have long expected. This has momentous implications for the stock and bond markets.
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A sharp eyed subscriber caught an error on the top of page 4 of this report. I typed “billion,” instead of “trillion,” twice, in reference to T-bill issuance for the quarter. The paragraph should read as follows:
How much more? The TBAC said that $84 billion in Treasury coupon paper (notes and bonds) will settle at the end of the month. It didn’t give details on short term paper issuance, but it projected $2.68 trillion in bill issuance for the whole second quarter. $2.25 trillion has already been issued or scheduled through June 16. That means another $440 billion or so to come in the last 2 weeks of June. In other words, total net new issuance for June 17-30 is projected to be $524 billion.
Sorry for the confusion!
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The Fed has now promised QE infinity. But will it be enough, in the face of Federal deficit financing to infinity and beyond? Because for every dollar the Fed has promised to print and pump through Primary Dealer accounts into the financial markets, the US government has promised to issue about $3 in new debt.
$1 of financing for every $3 of new Federal debt is a whole new game of QE Lite that is unproven. Under earlier versions of QE, the Fed always printed QE dollar for dollar of Federal debt. The Fed monetized everything through its middlemen the Primary Dealers.
Under Pandemonium Panic QE, back in March and April, the Fed actually pumped in $2 for every dollar of new Federal debt issuance. That drove a meltup in stock prices. Which in turn triggered a rebirth of animal spirits and wild speculation in a bubble within a depression, the likes of which we’ve never seen.
So is this bubble sustainable when the Fed will only buy a third of the Mount Gargantua of new Federal debt issuance each month?
I’ll just say, Harrumph! I highly doubt it. I explain why, herein.
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US Commercial Bank data had been sending warning signals that all was not well for at least a year before the stock market crashed. I chronicled that in these reports.
The warning signals came to fruition in February and March.
But then the Fed stepped into the breach and went crazy. What the Fed did, and is still doing, went beyond “unprecedented.” It was nuts. As a result, banking indicators have now gone where no man has ever gone before. I mean, we are talking outer space, baby!
By these measures, the Fed is promoting even more of what caused the crash. Orders of magnitude more. I can’t pretend to know with any certainty what the ultimate effects of unprecedented actions will be. Unprecedented means that we can’t rely on history to guide us. It is now a matter of instincts, logic, and common sense.
And those things tell me that this experiment in massive monetary inflation will result in… yep, massive monetary inflation. But how will it be expressed? Asset inflation? Consumer inflation? Stock price inflation? Bond yield inflation? Dollar collapse? Gold to the moon? Bitcoin to a million? Oil to a thousand. Wheelbarrows of cash for a loaf of bread?
I don’t know, but I have my suspicions, and they lean toward more consumption goods inflation, weakness in the dollar, and especially weakness in bond prices, that will ultimately bring down the whole financial system.
But I can’t have a high degree of confidence in that outlook because we have no historical precedents. To bastardize Santayana and Berra,
“We cannot remember the past or repeat it because it never happened before, making it even more difficult to make predictions, especially about the future for which there’s been no past.”
Let’s see that make it to Bartlett’s.
So I look on in slack-jawed wonder at these banking indicators doing amazing feats of acrobatics. It’s like in the circus, with ringmaster Jaysus Powell leading a troupe of clown priests of central banking, dancing, leaping, doing pratfalls, honking their bicycle horns. Throwing peanuts to the chimps screaching in their wake.
That’s what the banking indicators look and feel like. The Fed puts on a show. It hands out free tickets to all. It rents empty arenas from the busted sponsors. Stock prices go through the roof. But real business investment crashes.
This craziness can’t end well I think. But I don’t know how, and I don’t know when. I just know that Ringling Brothers, Barnum and Bailey are dead.
But do we even need to guess the future? Forecasts are of limited usefulness even under conditions of relative clarity. What matters are trends, and the indications of trend change. Recognize where we are, and when things are changing early enough, and that’s all we need.
It helps to recognize when the conditions are ripe for change. That’s where indicators like these can be helpful. Current conditions are wildly different from anything we’ve ever seen. That in itself suggests that change is gonna come. We need to be alert for the first signs, so that we can get out ahead of the crowd heading for the exits.
These indicators, in themselves, won’t help us with timing. That’s a matter for technical analysis. We’re getting some hints that change might be coming to the bond market. I really don’t want to be long Treasuries or fixed income of any kind now. It just seems too risky given the near zero returns.
And I sure do not want to chase stocks now. The TA that I do every week for the Technical Trader reports suggests that upside is limited in the short run. Maybe there will be a good entry for a long term hold in the next correction. Maybe not. We’ll make that call as we see it.
As for shorting stocks, I don’t see that at the moment either. I posted a bunch of stocks with short term sell signals last week and got taken to the woodshed. Fortunately I had almost as many long signals. They ended up perfectly hedging each other to near zero. Goodbye profits.
Not good. I should have had better recognition of and respect for the bull. Bullish trends will drop lots of false sell signals along the way. It’s critical that we not argue with context. Thinking about Rule Number 2- “The trend is your friend,” aka “Don’t fight the tape.”
Regardless of how crazy it looks or feels.
After all, markets are just meters. They measure how much money is in the system, showing that as index price levels. All of the reasons that Wall Street gives for what the markets are doing are just excuses for the money meter. There’s no “reason,” in logical, human terms. It’s just the money. Banking indicators are another way of showing us the money. Show me the money! See the market.
The Fed and its sister central banks have created a whole bunch more money in a few short months than ever in the history of mankind. The money coursed through the markets and into the banking system. As the markets have risen, even more credit has become available to drive prices higher. And so on.
The dealers love the game. They’re playing it to the hilt, but they are overextended, and overexposed to the bond market. The Fed can’t afford to allow yields to rise, and bond prices to fall.
I’ll be interested to see in Wednesday’s FOMC statement if they say anything about pegging bond yields. Because to do that, they would need to print money to the moon. God help us if they do.
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The line items of the Fed’s Pandemic Panic Emergency Programs get a lot of media and analyst attention these days. What a waste of time and energy. Let me explain why.
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We’ve watched this bizarre scene unfold where the Fed is gradually reducing QE, the Treasury keeps pounding the market with new supply and stock prices keep rising. Here’s how they did it, and what changes ahead will force a change in the outlook.
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We knew this was coming. $265 billion in MBS settlements for May are almost done. Now we reap the whirlwind. Here’s what to expect and why it’s time to GTFO.
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Lee Adler