Category: 1 – Liquidity Trader- Money Trends

Withholding taxes rebounded in January, but they were still negative year to year in inflation adjusted terms, and barely positive in nominal terms. Non-subscribers, click here for access.

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By any standard, the withholding tax data doesn’t support the jobs report.  Non-subscribers, click here for access. 

But that’s not what matters. Here’s what does.    Non-subscribers, click here for access. 

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The dealers have gone to an extreme of leverage against their bond positions for the second time since last July.  Back then, the extreme lasted for about a month, and it coincided with an intermediate top in stock prices and an accelerated decline in bond prices and the necessary inverse rise in yields.  Non-subscribers, click here for access.

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This report shows the pictures that tell the story, and that tells us what to do about it.

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Yesterday I posted a report on the plunge in the withholding data. Non-subscribers, click here for access.

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That conclusion may not have been correct. A reader brought to my attention that there was apparently a tax law effect. Another tax tracking service estimated that the effect of this change was 17%, so that there would have been a net year to year gain of 6.1%. This would have been the rate of change, in the absence of the effect of deferment of withholding in the prior year due to pandemic relief legislation. December 2022 was the giveback.

In reviewing the data, I noted that there was a 21% surge in year to year withholding tax collections in December 2022. You can see that on the withholding tax chart in the report. Non-subscribers, click here for access. Therefore the effect of the tax deferment may well have been 17%, or close to it. The analysis of that impact appears to be accurate.

Assuming the adjusted figure of a year to year gain 6.1% is correct, then the real growth rate would have been 2% based on recent BLS earnings inflation reported at 4%.  The adjusted data presented in the other report claims that withholding growth was equivalent to the BEA rate of wage inflation at 6%. That implies zero job growth.

I apologize that my analysis posted yesterday appears to be materially incorrect because of this factor. However, my broad conclusions remain the same. There’s still lots of Treasury supply on the way. The deficit will apparently not grow beyond the official forecast but it remains enormous and isn’t going away.

In January, the effect of the deferred withholding back in December 2021 that was recaptured in December 2022, will be zero. We’ll then get an apples to apples comp. I will provide an interim update on the January year to year change during the month.

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The market has reached maximum extension versus the Composite Liquidity Indicator. The indicator remains flat despite surging bank deposits. Investors and dealers appear to be pulling cash from money market funds to buy stocks and bonds. That’s bulking up bank deposits, in a bullish self feedback loop. Non-subscribers, click here for access.

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But that only can go so far as the Fed continues to work to blunt that via QT. QT or Quantitative Tightening is the act of the Fed shrinking its balance sheet, which in turn destroys bank deposits. Foreign central banks have also been uncooperative in supporting the bull moves in US stocks and bonds. That reduces systemic liquidity. Non-subscribers, click here for access.

In recent months animal spirits have resulted in enough private credit creation to outstrip the Fed. The US Treasury has goosed the process by stopping the issuance of more T-bills than are expiring. With a reduced supply of T-bills, investors have had more cash to play with, and play, they did. But all that will come to an end over January and February. There are already hints from these liquidity measures that a market top may be at hand. Non-subscribers, click here for access.

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Tracking total Primary Dealer financing, as reported weekly by the New York Fed, shows us the approximate level of risk inherent in dealer positions. This analysis includes not only their outright positions, repo financing, but also net Treasuries borrowed, which is a proxy for short positions that hedge outright positions held. We then include dealer fixed income futures hedges. This combined view tells us whether they are long or short on balance. It also gives us a view of how leveraged they are. Non-subscribers, click here for access.

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The dealers have gone whole hog in terms of repo borrowing and maximum leverage since September. They first got there in mid-July. That was reversed by a period of deleveraging that lasted into September, accompanied by weaker markets. But then they came roaring back, pedal to the metal, with maximum leverage. Non-subscribers, click here for access.

At the same time, money has poured out of the Fed’s RRP slush fund at a breakneck pace as investor psychology turned more and more bullish. The Fed even followed the crowd this week, suddenly pivoting its guidance toward rate cuts next year, surprising the markets. Non-subscribers, click here for access.

$900 billion in cash has come out of the Fed’s RRP facility since September. Market participants have used that cash to buy not only T-bills, but also stocks and bonds. Combine that with the increased use of leverage by the dealers over that same period, and a temporary reduction in Treasury supply in December, and the stock and bond markets have been on fire. Non-subscribers, click here for access.

This too shall pass, but the question is when. The Primary Dealer positioning data alone doesn’t tell us that, but it does give us an idea of the elevated level of risk. It suggests that when Treasury supply returns to normal, and the RRP slush fund runs dry, the markets could be in for a sudden and violent turn. Non-subscribers, click here for access.

I initially estimated in prior reports that the RRP facility was heading toward zero in xxxxx, but as the pace of withdrawals has accelerated in the past few weeks, we adjusted that to xxxxx. The current data through Friday suggests that that’s still the target. But before that, Treasury supply will mushroom again xxxx xxxx , and will be heavy in xxxxxx. The ruts in the road should start to show up then. Non-subscribers, click here for access.

With the Fed’s pivot in rhetoric this week, the euphoria has been thick. Light T-bill supply until xxxxxxx xxxxxxx xxxxxx should keep that going. Meanwhile investors and dealers have continued pulling money out of the Fed’s RRP facility at a breakneck pace over the past couple of weeks with no T-bill supply driving that. That means that instead of simply buying T-bills as they usually do with that cash, with the T-bills then being used as collateral for more repo borrowing, dealers and investors have gone to directly buying stocks and bonds. Non-subscribers, click here for access.

I see no reason for that to change over the next xx xxxxx. But a big Treasury coupon settlement in xxxx xxxxxx xxxxxxx should present a roadblock, with more supply in xxxxxx xxxxxxx xxxxxx xxxxxxx giving an overleveraged dealer market a reality check. Non-subscribers, click here for access.
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When the 10-year yield hit 5%, we recognized that it was time for a bond rally. It has come with a vengeance. Now it is time to start looking for signs of a bearish turn there as we head into xxxxxxxx xxxxxxx xxxxxxx. Stocks should follow suit as investors wake up to the fact that the cash that fueled the buying frenzy will soon run out. Non-subscribers, click here for access.

Bottom line, I would not be xxxxxxx xxxxx xxxxxx xxxxxx but xxxxx xxxxxxx xxxxxx xxxxx. Non-subscribers, click here for access.

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