Tax collections have leveled off at a negative year to year rate. That will allow the Fed to continue to paper things over at the current level of support it is providing. Here’s what it means for stocks and bonds, not to mention the US economy.
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No news isn’t no news. The Primary Dealers are in the same posture they’ve been in. They’re still bullish on bonds and that’s an extremely dangerous situation.
It’s like that warehouse packed with explosives in Beirut. One small fire could ignite a conflagration of biblical proportions.
The dealers continue to maintain historically large fixed income positions. Those positions hit record high prices. They’ve accumulated a good bit of inventory near the highs. They remain highly leveraged. Worse, they’ve reduced their futures hedges significantly. They are positioned for even more or a bullish environment in bonds.
This report gives you the keys to look for.
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The Treasury’s numbers for June were as bad as expected. Early July numbers look good, but it’s a trick. Here’s how we know, and what that means for the markets.
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The Treasury’s numbers are in for June and they’re not good. First things first. The BLS jobs data is just BS.
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Common sense says that as case numbers increase, tax collections would fall and vice versa, REGARDLESS of whether governments imposed lockdowns. So my expectation was that as governors across the country lifted restrictions, case numbers would rise, and tax collections would fall.
Well here we are.
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The data is noisy, and week to week the changes may not mean much. But in some weeks, it’s obvious that it’s part of a bigger trend, whether confirming or indicating change. Even if there are just hints, this information can be incredibly useful. It is useful because it tells us exactly what the big picture is, while Wall Street economists are still scratching their asses and trying to figure out what the government statistician manipulated data means. And the first report from that data is still 13 days away.
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The Monthly Treasury Statement for May confirms that the economy rebounded during the month, but more recent data through last week suggests that the rebound has already expired. Signs of renewed weakness come when the numbers are still far from a full recovery. The economy is beginning to weaken again, starting from weakness.
That’s relevant because it means that the Federal government will need to continue to issue massive amounts of debt. It may not be quite as much as in March and April, but it will still be at least double past peak levels.
We also know that the Fed has sharply cut the amount of that debt that it is directly absorbing or financing.
Here’s what this means for your investing strategy.
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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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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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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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Lee Adler
