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Category: 1 – Liquidity Trader

Reports on the Fed and Treasury, Primary Dealers, real time Federal tax collections, foreign central banks, US banking system, European banking system, and other factors that affect market liquidity. Resulting market strategy recommendations. 7-8 reports each month. Click here to subscribe. 90 day risk free trial!

Is QE Infinity Enough?

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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Show Me the Money! See the Market

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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Here’s Why A Recovery Narrative Will Be Catastrophic for Markets

To the degree that it’s true, the idea that the US economy is recovering is a catastrophic notion for the financial markets.

Surprisingly, the withholding tax data supports the idea that a small number of jobs did come back in May. The problem is that the bond market reacted as if a big recovery is on the way. Investors and traders, made a mountain out of a molehill.  Bond prices plunged and yields soared. This is exactly the opposite of what the Fed and dealers wanted and needed. If it’s not reversed immediately, to say that it will be problematic would be an understatement.

Here’s what you need to know.

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Dealers Don’t Care That Fed is Tightening, But They Will on Friday

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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Dealer Dementia, Payback Delayed but Not Denied

I’ve marveled at the ability of the players to keep stock prices rising despite the reduction of Fed QE, and the continued pounding of Treasury supply on the market. Even more amazing is the fact that the rally in stocks has NOT come at the expense of the Treasury market. The Treasury market has managed not to blow up.

“How are they doing it?” I have wondered. And WTF does it mean for the future?

I have some answers, but not all. Obviously, as much as I’d like to get there for your benefit, I have never come remotely close to finding all the answers. Fortunately, I just need enough of the right ones to get the direction of the market right. Right now is a particularly difficult time for that. The Fed is barely absorbing 20% of new Treasury issuance and bond prices stay high and stock prices keep going higher?

My thinking has been that, no, you’re not wrong, Lee, the market is overstretched and vulnerable.

How can this be happening? Simple. The dealers and other big market participants are again piling on more leverage. They’re making the same mistake they always make right before everything blows up. The shock is how quickly they forget the lessons of recent history. Short term memory loss I guess. It’s dementia. That’s it. The dealers have dementia.

So here we are. Yet again, those who do not remember the past are condemned to repeat it. Here’s why, and what to do about it.

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Primary Dealers Go Hog Wild Net Long Treasuries

Back in December I had no idea that a pandemic was coming. I had no idea that COVID19 would cause Treasury supply to increase 10x. Nor did I know that the Fed would buy all of it at first, and then that it would experiment with cutting back until “who knows what.”

But that’s what happened, and that’s what the Fed has done and is doing. I was concerned about supply demand back then, but I had no clue how understated my concern would be. Here’s what I wrote 6 months back.

12/18/19 Primary Dealers continue to carry all-time record inventories of fixed income securities, far above their historically normal bond positions. They are not well hedged. They are overwhelmingly net long and they are massively leveraged…

Furthermore, with more and more Treasury supply constantly on the way, the Fed must keep buying and/or lending the cash to buy to its straw men the Primary Dealers indefinitely. The dealers and the market at large is in no position to absorb $100 billion a month in new Treasury supply.

So the Fed is now trapped. It can’t simply end Not QE without risking a massive system wide crash. It must continue to add cash to the market indefinitely. But can it continue to print endlessly without horrific unintended consequences?

And what will those consequences be? Endless asset bubbles to the sky? Increasing consumer inflation that ultimately leads to hyperinflation?

When the pandemic hit, the Fed at first was flummoxed. It had been printing since September when the money markets blew up, but it wasn’t printing enough. And it was slow to react. So stocks crashed. That’s when the Fed went into panic mode and began printing money as if there would be no tomorrow.

Let’s be clear about one thing. The Fed did not swing into action to rescue the US economy from depression. The Fed’s first order of business when the SHTF was to rescue the Primary Dealers. Which it definitely did.

The dealers were leveraged to the hilt with record long positions in Treasuries. The Treasury was already issuing a trillion a year in new supply. That forced the dealers into the position of having to buy and own mass quantities of US Treasuries. The pandemic meant that they got well paid for that because yields collapsed and Treasury prices soared as the world’s investors dumped stocks and headed for the perceived safety of Treasuries.

But dealers took it on the chin when stocks and all other assets crashed. There’s no question in my mind that they were down and out at that point. We may never know how bad things were. The Fed papered over their problems by buying a couple trillion of their Treasuries and MBS at record high prices.

But we may still find out just how bad things are. Because the dealers remain leveraged to the hilt. And there’s one more thing.

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Treasury Issuance Catches Up With QE and That’s Not Good

Treasury issuance has caught up with QE. There are no more excess funds lying around for dealers to use to mark up stock and bond prices. The balance has shifted. It’s not as bullish as it was, that’s for sure. And it could get much, much worse in the weeks ahead before the Fed reacts.

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Federal Withholding Tax Collections Chart

You Have No Idea How Bad This Really Is

In normal times, the Federal Government has a revenue windfall in April, and runs a large surplus for the month. Revenues are typically at least 140% of outlays. Even more in good years.

Revenues covered just 24% of outlays in April. We borrowed 76 cents of every dollar the Federal Government spent last month.

We knew this was coming. The questions now are how long it can last, when it will start to recover, and whether it might get worse.

The monthly Treasury Statement data illustrates the depth of the budgetary crisis that have engulfed the financial markets. It showed that the Federal Government had to finance a deficit of $742 billion for the month. But that apparently doesn’t include a little cash flow matter of $230 billion the government paid out in tax refunds in April. That’s a gargantuan number that we saw in the Daily Treasury Statement data that I reported last week. Therefore on a cash basis, the deficit was more than a trillion. That had to be financed through debt offerings.

The Daily Treasury Statement data through May 12 shows that the situation is not only not getting better. It hasn’t stopped getting worse. The worst readings on withholding tax collections just happened Friday and Monday. Here’s how it looks now, and guidance on how we’ll know when it’s beginning to recover.

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