Liquidity Trader

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The Federal budget deficit is shrinking as the economy experiences an inflationary boom. This is just what the Fed was hoping for, but inflation has obviously gotten away from them. It will only get worse as the lagging rent component of CPI will push the total index higher, even if and when the other components begin to moderate.

The rent of shelter and owner’s equivalent rent that’s based on it make up about 40% of Core CPI. Those two components are not based on real time market rents. They’re based on a survey of renters, asking them what they’re paying. The OER is derived from that as a base, and then adjusted from time to time by asking homeowners how much they thought their houses would rent for… As if they knew.

This isn’t merely a dumbass way to measure rent inflation, it’s fraud. Contract rents are usually adjusted upward at a rate far below the increase in market rent. That’s because landlords like to keep good tenants in place rather than incur the friction costs of raising the rent too much and having them leave. It costs money to find a new tenant, and spruce up the unit.

So when the BLS asks tenants what they’re paying, it does not get the full effect of the currently soaring rents. Apartment List does a national rent report showing rents up 17.8% year over year. BLS has imputed the rent component of CPI at 4.1%. At 40% of core, this difference means that the BLS is understating total Core CPI by roughly 5.5 percentage points. That’s obscene. It’s an affront to human intelligence.

But CPI was never intended to measure inflation. That’s why they took home prices out of the index in 1982. CPI was always intended as a tool for indexing government wages and benefits, and industrial labor contracts. In the 1970s indexing got too expensive as home prices surged. So they worked out a way to remove house prices and falsify the housing component of CPI beginning in ‘82.

Now, the Fed is devaluing the mountain of debt out there. Bond holders will get a small fraction of their purchasing power back if they hold to maturity. And if they don’t, and sell along the way they’ll get killed on the capital loss as a result of collapsing bond prices.

We saw this coming since about a month after the bond market turned in August 2020. I don’t think it will get better any time soon, although certainly there will be bond rallies from time to time. Still consistent with my message of the past 18 months, they’ll be xxxx xxxxx (subscriber version).

Meanwhile, the budget deficit will narrow as long as the economy booms. That will reduce Treasury supply. But it won’t reduce it to $20 billion a month. Maybe it will fall to an average of $60 billion per month as some forecasts suggest. Maybe it won’t. I don’t know. The economy is booming at the moment, and there’s no reason yet to expect a slowdown.

But it doesn’t matter. Because the market has shown that it can only absorb $20 billion per month while the Fed kept bond prices stable and suppressed by buying or funding $180-$200 billion per month in net new supply.

Now, if the Fed isn’t buying, and the market can only absorb $20 billion per month, with supply even as low as $60 billion, that’s $40 billion in excess supply that the market can’t take at a stable bond price.

Therefore, bond prices will xxxx xxxxx (subscriber version) and so will stocks, as they get xxxx xxxxx . They’ll be xxxx xxx xxxxxxxx xxxxxxxxx on leveraged funds who hold both stocks and fixed income. And they’ll get xxxx xxxxx because eventually rising yields will force some money managers to xxxx xxx xxxx xxxxx.

There will be no xxxx xxx xxxxx, except to xxxx xxxxx (subscriber version). I’ll continue to look for xxx xxxx trading opportunities in the Technical Trader reports. I’ll leave xxx xxxx the bond market to whale hedge fund professionals.

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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.

Subscribers, click here to download the report.

Subscription Plans

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