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The Fed poured $132 billion of QE into the accounts of Primary Dealers between October 14 and 21, the regular monthly MBS settlement week. As a result, we got the usual predictable result of a rally in stocks.

But there was only a weak, late holding action in Treasuries. They sold off for most of the week. That’s understandable, considering that the US Treasury sucked $218 billion out of the market that week after the debt ceiling was lifted.

It will pull another $196 billion out this week. At this rate, they’ll hit the new debt limit by xxxxx xxxxxxxxxx (subscriber version). Then the extraordinary measures game and the political/fiscal brinksmanship will begin anew.

At the same time, the Fed will begin cutting its outright QE purchases, and MBS replacement purchases will also decline because of higher rates and few mortgage refis, and thus prepayments. That would normally be very bearish, but remember! They have a slush fund! The Fed’s RRP account, which currently still holds about $1.4 trillion in cash ready to absorb the flood of new T-bills.

In the context of all this new supply pounding the financial market, the stock market rally was pretty remarkable. Stocks rose despite the fact that there was more Treasury supply than there was QE. True, there’s still plenty of cash sitting in the Fed’s RRP slush fund. As I’ve pointed out, this will cushion and help to absorb the supply hit coming from the US Treasury.

Think of the RRP slush fund as a big pot of beans simmering on the money manager cowboy camp fire. Fed QE adds more beans to the pot. The US Treasury keeps eating mass quantities of the beans. It constantly refills its plate, consumes the beans, and passes the gas into the US economy. It can continue to consume those beans until they’re gone, as in when the RRP fund is exhausted. That will happen in some months, especially as the Fed gradually stops adding beans to the pot (tapering QE).

Or maybe not that long. Maybe some of those money managers tending the pot will at some point will be like Mr. Taggert. In response to the Treasury asking for still more beans, they’ll say “I think you’ve had enough!”

That’s when both the stock and bond markets will get really interesting for bears. Of course in my view, the bond market is already plenty “interesting,” and has been for some time.

Media reports have pointed out that professional money managers are overwhelmingly bearish on bonds, as if that’s some kind of contrarian bullish omen. I hate to be a party pooper, but market consensus is often right for long periods, especially when the facts support it. In this case, the facts support the consensus. So I’m xxxxxxxx xxxxxxx xxx xxxxxxx (subscriber version). Treasuries. I wouldn’t want to hold long term debt in this environment.

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Secretary Yellen Says that the Treasury will run out of cash on October 18. Sounds about right.

When the Treasury runs out of cash, Congress will be forced to raise the debt ceiling. When it does, look for a xxx xxxx xxx xxxx xxx xxxx (subscribers’ version).

Given the current political climate, a government shutdown is a given. A delay in lifting the debt limit, and a technical default by the US government is a definite maybe. It would almost certainly be disruptive to the markets in the short run, but in the longer run, the default will be cured, and the effect will fade into the background.

The Fed’s RRP slush fund is now nearly $1.5 trilllion. I had forecast that it would top out around $1.3 trillion. Bulls get a bonus. That will fund the new supply tsunami for xxxx xxxx (subscribers’ version) months. Everything could look ok during that time. The Fed will be praised for its brilliance, and the markets will have an uneasy peace, if not a resumption of bullish trends.

However, as that fund begins to run out, the cracks will appear. And once that fund is drawn down to zero, the ingredients for a massive xxxx xxxx xxxx xxxx (subscribers’ version) will be in place. The bitter fruit of QE, and tapering QE, will be tasted.

The timing of that depends largely on how fast the Treasury xxxxxxxxxx xxxxxxxxxxxx xxxxxxxxxxxx xxxxxxxxx (subscribers’ version). So far, that amounts to at least $600 billion to be added to structural supply needs over the course of a few months.

This month, the Fed’s QE has been covering, and will continue to cover 104-107% of new Treasury issuance, until the debt ceiling is lifted.

That should have been a short term bullish factor for bonds and stocks, as it pumps cash into the dealer and other institutional accounts that had been the holders of the T-bills being redeemed. But it hasn’t gotten traction. Smart money is getting out ahead of what they know is coming. The xxxx xxxxx (subscribers’ version) situation plays a role in generating margin calls that trigger liquidation pressures in other assets xxx xxxx xxxxxx xxxx (subscribers’ version). That includes especially, highly liquid US assets.

Another factor pressuring prices is record corporate debt and equity issuance.

Previously I wrote:

8/26/21 In fact, it’s surprising that the stock rally has been so muted, and that the bond rally has stopped in its tracks over the past 6 weeks. That’s because corporations have been rushing to issue new equity and new debt to take advantage of the high prices they can get. This is free money to them.

9/15/21 I had forecast this last year, and have reported on it several times this year. Just this week we began seeing mainstream media news reports confirming record levels of corporate issuance.

8/26/21 Once the Treasury begins to issue new debt, it will be on top of this gigantic wave of corporate supply. It won’t be pretty.

It also won’t be immediate. I estimate that by the time the debt ceiling is lifted and the Treasury supply tsunami starts, the Fed’s RRP slush fund will reach about $1.3 trillion. That’s how much new Treasury debt can be issued before the crisis becomes apparent.

8/26/21 We have a few months. Xxxxxx xx xxxxx xxx xxxx (subscribers’ version), but we’ll have the meters of the Fed’s RRP account, and the schedule of new Treasury issuance, as well as the QE schedule. If the Fed chooses to reduce that schedule, that’s their problem, and the market’s.

But it won’t be ours. Because we’ll be actively watching, with situational awareness. We’ll hopefully be prepared to take advantage with enough advance notice to act accordingly.

9/15/21 It’s been reported that the Fed will begin its “taper,” which are small reductions in the amount of QE purchases it makes, in November.

Meanwhile, the 10 year Treasury yield has broken out to the upside. We expected that. But I didn’t expect it to happen this quickly. I attribute it to front running, xxxx xxxxx (subscribers’ version), and record corporate issuance, all of which are sucking money out of the market as fast or faster than the Fed pumps it in.

In conclusion, I repeat what I wrote in mid September. 9/15/21 It’s a recipe for disaster. So I reiterate my view that xxxx xxxx xxxxx xxxxx xxxxx xxxxx, (subscribers’ version) a view that so far, appears to have been remarkably prescient.

Below are a few previous summary observations which remain relevant. Supporting data, charts and analysis follow that (subscribers’ version).

8/13/21 The Wall Street talking head community, with a few Fedheads chiming in, is now in a growing chorus that the Fed will start tapering soon. Our analysis has been that the Fed can only taper if the Federal deficit is shrinking, thereby reducing Treasury supply. If the Fed were to taper in the face of constant or rising supply, the market would need to adjust in order to absorb the additional supply. Bond prices would fall and yields would rise.

This is where the revenue trend is important. If it weakens, the deficit will grow and supply will increase. This is even before considering the infrastructure spending package. If revenue growth stays strong, the Fed could conceivably do a small cut in QE (aka taper) without crushing the bond market. That could turn into the muddle through scenario.

The Treasury market rally of recent months has meant that Primary Dealers have built a profit cushion that would provide some protection in the event of bond market price weakness. In addition, initially, the supply increase that results from the lifting of the debt ceiling will be funded by the trillion + dollars that has been deposited in the Fed’s RRP program. That is still growing as the Treasury continues to pay down T-bills.

Those two factors will delay a bond market crisis for a couple of months. It’s difficult to estimate for how long, with any certainty.

It depends on when the debt ceiling is lifted, how much tax revenue the US economy is generating, and how much the Fed cuts its purchases of Treasuries and MBS as it begins the “taper.”

A muddle through scenario is always possible, but a crisis is also possible, if not more likely. The timing is in question, but it should come xxxxxxxxx xxxxxxx xxxxxxxx (subscribers’ version). The timing will become clearer as the trends of the data begin to show themselves once the debt ceiling is lifted. That includes the supply schedule, the trend of Federal revenue, and the Fed’s schedule of reduced purchases.

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Janet Yellen has now confirmed that the Treasury will run out of money in October, as we already knew from our tracking of the data.  Congress will be forced to raise the debt ceiling. Treasury supply will mushroom at the same time as the Fed begins to cut its market support operations. The RRP slush fund will affect the timing of the coming disaster. But we know its coming and we have a good idea of when.

Meanwhile the BLS has fomented a completely false picture of inflation. I explain that in this report. It’s blatant.

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Treasuries have sold off on the strong, surprise jobs report last week.

At the same time, there’s been an equally important, but less well known surprise. The Treasury has maintained an increased pace of T-bill paydowns in the first third of August, despite the re-imposed debt ceiling.

That’s a short term bullish factor for bonds as it keeps pumping cash into the dealer and other institutional accounts that had been the holders of the T-bills being redeemed.

But it also means that the Treasury will spend its cash faster than I had initially imagined. That means that the bullish influence will end sooner than in my last guess.

I use the word “guess” deliberately. It’s difficult to estimate of what brilliant, but crazy, policymakers will make up when the heat is on.

The good news is that we now have evidence of a pattern. That pattern shows a fast spenddown. At this rate of spending, the Treasury will run out of cash in xxx xxxx (in subscriber report). As I recall from the past 7 debt ceiling debacles, there’s also a legal mandate that the government must make a large military pension fund contribution at the end of the fiscal year which will affect the drop dead date.

Maybe they can delay that for xxxx xxx xxxx (subscriber report) depending on the strength of mid September quarterly income tax collections. But at some point in xxxxxxx, the pressure to raise the debt ceiling will force a deal.

The jobs data was a surprise. As usual, the BLS first release is BS. The July nonfarm payrolls report grossly overstates the increase in jobs. The tax data is actual and, as I pointed out in the monthly Federal revenues report posted last week, withholding tax collections show that the payroll gains were certainly less robust than the BLS said they were.

As you may recall, back in the spring, there were a couple of months were the nonfarm payrolls gains were severely underreported relative to what the withholding tax collections were showing. I wrote then that the BLS data would catch up to the reality within a few months. I believe that the July report was the “catchup” month.

In our report on July federal withholding collections, we saw a dip in the second half of the month that suggested that the economy had fallen off a cliff. But withholding has now recovered to the trend in force since mid May (CHART in subscriber report). It is now at an inflection point where it should signal whether the economy has gotten back on track, or is in the process of rolling over. This should happen over the remainder of this month. I’ll post an updated chart when it happens.

The Wall Street talking head community, with a few Fedheads chiming in, is now in a growing chorus that the Fed will start tapering soon. Our analysis has been that the Fed can only taper if the Federal deficit is shrinking, thereby reducing Treasury supply. If the Fed were to taper in the face of constant or rising supply, the market would need to adjust in order to absorb the additional supply. Bond prices would fall and yields would rise.

This is where the revenue trend is important. If it weakens, the deficit will grow and supply will increase. This is even before considering the $1 trillion infrastructure spending package. If revenue growth stays strong, the Fed could conceivably do a small cut in QE (aka taper) without crushing the bond market. That could turn into the muddle through scenario.

The Treasury market rally of recent months has meant that Primary Dealers have built a profit cushion that would provide some protection in the event of bond market price weakness. In addition, initially, the supply increase that results from the lifting of the debt ceiling will be funded by the trillion + dollars that has been deposited in the Fed’s RRP program. That is still growing as the Treasury continues to pay down T-bills.

Those two factors will delay a bond market crisis for xxx xxxx (subscriber report).

It depends on when the debt ceiling is lifted, how much tax revenue the US economy is generating, and how much the Fed cuts its purchases of Treasuries and MBS as it begins the “taper.”

A muddle through scenario is always possible, but a crisis is also possible, if not more likely. The timing is in question, but it should come xxx xxxx xxxx xxxx (in subscriber report). The timing will become clearer as the trends of the data begin to show themselves once the debt ceiling is lifted. That includes the supply schedule, the trend of Federal revenue, and the Fed’s schedule of reduced purchases.

In the meantime, the status quo rules. As long as the Treasury is using its cash to pay down t-bills, the uptrend in stocks should continue. The selloff in Treasuries over the past week should reverse as those paydowns continue.

See the full report for the charts, more details on the supporting data and how we arrive at these conclusions, along with the timing, and an idea of the appropriate strategy under these conditions.

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