Category: 1 – Liquidity Trader- Money Trends

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Not much has changed since our last look at Primary Dealer data 4 weeks ago. The script is playing out. It’s Greek tragedy, because we know what’s coming. I’ll recount what we’ve already said, and add plot embellishments from current data that the Fed posted Thursday, that’s up to date through 10 days ago.

The bottom line is that the financial market is moving towards a crisis. Fast. It will continue to do so as the Fed cuts QE first to zero, then goes in reverse. It will do so even more as the Fed shrinks its balance sheet by allowing maturing paper to be paid off rather than rolled over. If they do that, the pressure on on Primary Dealers will only get worse. They have not established the net short positions needed to manage it.

On average, their positioning is not good for a decline in bond prices (rise in yields.) Some Primary Dealers are probably well positioned. That means that some, if not most, are not. Those who are not well positioned are almost certainly already in trouble.

This won’t end well.

This report has the charts and analysis to prove it.

I’ve opined to stay away from the bond market for the past 18 months. Has that now changed? And what about stocks?

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Withholding Tax collections remained strong in January. A sharp drop in the year to year change was due to an increase in the base of comparison a year ago, and is not a sign of economic weakening. At least not yet.

Withholding collections should be at or near the trough of their usual 2-3 month cycle. So the ADP private payrolls collapse notwithstanding, and regardless of what the BLS says this morning, jobs growth is not decelerating. At least not yet.

But even if the economy is strong and the market must only absorb $80 billion per month of expected new supply versus the $$150 billion -$200 billion per month of the past couple of years, $80 billion is still more than enough to disrupt the markets if the Fed isn’t buying.

Here’s why (subscriber version).

We know that the Fed was usually absorbing or funding about 85-90% of total supply, leaving the market to absorb the rest. That was enough to suppress the 10 year yield at or below 1.3%. At the time, new issuance was averaging around $200 billion per month. So the market was only absorbing $20-30 billion per month, outright. The Fed was buying or funding the rest.

When the debt ceiling was reimposed last year, supply was restricted, but the Fed maintained QE at the same pace. That meant that it was funding more than 100% of supply for a couple of months. That excess cash was sloshing around in Primary Dealer accounts. They put it to use by accumulating, marking up, and distributing stocks to a fevered customer base of institutions, hedge funds, and small traders. That caused the meltup in stock prices.

The arithmetic on Treasury supply versus market demand tells us that the average supply of $80 billion per month is more than the maximum of $30 billion per month that buyers were absorbing directly while holding bond prices stable. In other words, $30 billion in supply was what the market could bear without prices falling and yields rising. The Fed subsidized the rest.

Hence, without Fed buying,we should expect  …. (subscriber version).

And that’s with an expanding economy and growing tax revenues. If the economy contracts on the heels of market dislocations, that will only exacerbate the situation.

In order to absorb the Treasury supply, dealers, investors, and traders must either take on more debt, or liquidate some of their existing holdings, whether Treasuries or stocks. I suspect, based on the evidence of the past two months, that …. (subscriber version). For that reason, I’m focused on selecting swing trade chart picks on  …. (subscriber version). in the Technical Trader weekly reports.

I’ll keep you updated on the developments and outlook. Get the full story in the subscriber version.

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Correction: In paragraph 4 I have corrected the line about the dealers’ net position to “net long.” In the original version I inadvertently wrote “net short.” That was an error. Sorry for the confusion! 

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The Fed provides us with a tremendous amount of information and data. Some of it is highly useful. Most is not, from my perspective of trying to figure out how it will influence, or even to some extent control, market direction.

One area of useful information is the data that the New York Fed publishes every week with a 9 day lag on Primary Dealer positions and financing. The dealers run the markets, after all, so it’s good to have some insight into their positioning and leverage. It can, at times, give us a heads up that trouble may be brewing. We saw that over the past year as the dealers began to reduce their massive, and massively leveraged, fixed income portfolios.

I have pointed out that that was a huge problem, because a decline in bond prices could put them under water again, just as during the pandemic panic of March 2020. The problem was so big then that the even more massive Fed bailout looked as though it wasn’t working for about 8 days. Then it did work, and the market turned. But it was a close call.

In recent months we saw the decline in the dealers bond positions, but they were still net long and still leveraged. I warned that as bond prices fell and yields rose, their profits would be pressured, and if it continued, their capital could be wiped out again.

The dealers are really just hollow shells acting as strawmen for the Fed, buying Treasuries from the US government, and MBS from Fannie and Freddie and the FHA on the Fed’s behalf. Meanwhile they play side games accumulating, marking up, and marketing all manner of other assets, particularly stocks.

But now the Fed is getting out of the buying business. No more backstopping the dealers with constant massive funding. Meanwhile, the dealers are still REQUIRED, by virtue of their status as Primary Dealers, to still buy Treasuries.

How exactly will they be able to do that without steadily being cashed out by the Fed to the tune of a hundred and some billion per month, month in and month out?

The Fed will probably tell us tomorrow that it’s going to zero purchases after March.  The dealers must keep buying. There are only two ways they can fulfill that responsibility. They’ll either have to sell stuff first. Stuff, as in other Treasuries, other fixed income instruments, OR, drum roll please…… Stocks! Or they will need to borrow more money, that is, increase their leverage even more.

We’ve seen all of those processes in action in the past two weeks. We’ve also seen them report lower than expected profits. Why? Because they’re getting their asses kicked on those massively leveraged net long positions in fixed income.

And the Fed thinks that it can just withdraw from supporting the market with its massive money printing operations to buy virtually all of the debt the US government issues? Well as I told you before, oh, you can’t do that!

This little demonstration we’ve gotten over the past two weeks is just a taste of what’s to come until the market again forces the Fed to reverse course. We don’t know where or when that will be, so for now we just rely on Rules Number One and Number Two.

1. Don’t fight the Fed. and,
2. The trend is your friend aka, don’t fight the tape

Bounces in both the bond and stock notwithstanding, the Fed’s policy is clear, and the trend is clear.

In the last version of this Primary Dealer update in December I wrote, “At the very least, we need to be prepared for a sharp selloff in stocks, and what should turn into a resumption of the bear market in Treasuries.” 

Nailed it.

Find out what to expect now and what we’re doing about it in this report.

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It’s that time of the month and that time of the quarter when all should be well for the markets. Except it’s not.

“That time of the month” is the Fed’s regular once a month MBS settlement week at mid month. This month it runs January 13-20, with total settlements of $90 billion. That’s still a big number, but it isn’t doing much good. And it will shrivel over the next several months as the Fed cuts new MBS purchases and replacement purchase shrivel due to rising mortgage rates. Therefore, right now is as good as it gets for the bond market, and secondarily for stocks.

It’s also the week for quarterly estimated Federal income taxes to come in from individual filers and corporations. That shrinks the monthly deficit in January. In normal times it would result in a surplus for the month. Typically the Treasury would then pay off some maturing T-bills, and the holders of those bills would be stuck with excess cash. Some of them roll that out to longer dated paper and a few even buy stocks. So it’s typically a short term bullish seasonal influence around the third week of January.

This year, not so much. The Treasury still is trying to refill its cash account and has $160 billion to go to reach its stated goal of holding $650 billion in cash. So the “January effect,” which is really just bullish seasonality resulting from the regular January T-bill paydowns, looks like a non starter this year. The performance of the stock and bond markets so far in January are a testament to that.

If the market doesn’t perk up over the next few days, then here’s what we have to look forward to.

February will be worse. xxxx xxxx xxxx xxxx (subscriber version). February always runs the largest cash deficit of the year as tax receipts dwindle and cash outlays mushroom due to the February tax refund bulge. The Treasury often draws from its cash account to pay for that, rather than issue new debt. But this year, the Treasury is trying to raise more cash. There’s going to be a ton of new Treasury supply in February and that will pressure not only the xxxx xxxx xxxx xxxx, but should have a secondary impact on xxxx xxxx xxxx xxxx. This report describes those impacts, and their timing.

My mantra is the same. I’m xxxx xxxx xxxx xxxx (subscriber version) bonds. I’m looking for stocks to short over the next few weeks for what should be a bearish month in February. I’ll post those in Technical Trader updates as they come up.

With the Fed cutting QE to zero, or so it says, the rest of the year could be xxxx xxxx xxxx xxxx(subscriber version). The Fed is worried about inflation. Rightfully so. A little too late, but what else is new.  Might it now be willing to pull a “Volcker,” allowing rates to soar, and allowing the chips to fall where they may? If they dare try it, the market’s retribution will be xxxx xxxx xxxx xxxx.

I’ll keep you updated on the developments and outlook. Get the full story in the subscriber version.

Subscribers, click here to download the report.

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KNOW WHAT’S HAPPENING NOW, before the Street does, read Lee Adler’s Liquidity Trader risk free for 90 days!

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

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The debt limit has been raised. The Treasury has flooded the market with supply, and will continue to do so for another month or two. But there’s been no disaster in the market. The Fed’s RRP slush fund, designed to absorb the flood of supply, has even grown, thanks to year end window dressing.

Even after that window is undressed this week, there will still be around $1.6 trillion in that fund to start. That is overnight liquid money that holders will use to buy new Treasury issuance. The RRPs will gradually be drawn down. But there’s enough there to absorb the ongoing supply bulge that the government needs to issue to rebuild its cash and repay the internal accounts it raided while the debt limit was in place.

We don’t know exactly how much more the government needs to get its internal accounts back to normal, but it could achieve that purpose very quickly given the availability of the RRP fund. It holds more than enough cash to fund that issuance.

That RRP fund, with it’s baseline starting point of approximately $1.6 trillion also gives the Fed cover to wind down QE to zero in March. The Fed will cut QE, and everything will look hunky dory. Wall Street will conclude that “tapering” QE was no big deal. Market complacency will be thick. Get out your carving knives.

Once the Fed has cut QE to zero, and RRP holders decide that they will spend no more to support the market, is that when the crisis begins?  No, not immediately.

First, there will be the annual tax windfall that occurs in March and April, when corporate and individual income taxes for the preceding year come in. The Treasury always uses that cash to temporarily pay down outstanding debt. The holders of that debt get money back. They use that cash to buy longer term paper, and in some cases to buy stocks. So we get a seasonal rally every year in March and April.

But in late May, the Treasury starts net borrowing again. Then we watch. We watch to see how that RRP fund is doing. Once it turns flat, and there’s no more QE, and the seasonal tax windfall cash has been spent, that’s when the trouble starts in the market.

Sell in May and go away? This report tells you why that might be a good idea. The report shows what to expect for both stocks and bonds, along with the why’s and wherefores, likely timing, to give you a clear grasp on on a strategy and tactics that might make sense for you.  Get the full story in the subscriber version.

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KNOW WHAT’S HAPPENING NOW, before the Street does, read Lee Adler’s Liquidity Trader risk free for 90 days!

Act on real-time reality!

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