Liquidity Trader

Back in September I wrote to you about why I was giving up on the banking system indicators. I’ve reposted that rant in an addendum to this report. Essentially it boils down to this. Every time there’s a critical problem in the banking system due to banker malfeasance, the Fed steps in to paper it over and reward the criminals.

That’s why we focus on the Fed more than anything else.

The banking indicators were useful once upon a time. The Fed has rendered them irrelevant. But I promised to keep an eye on them, so herein is a review. It makes me sick and should make you sick too, but we’re not here to fight the Fed. We’re here to make money by understanding and playing according to the Fed’s rules. The Fed’s first order of business is always to protect its banker clients. And it does that very well indeed.

Once again trouble is brewing, and the Fed will need to come up big again to prevent it from blowing up the banking sector. If history is any guide, the Fed will be there. It may be to the detriment of those who don’t own capital, but they don’t matter. The Fed doesn’t care about them, and refuses to take responsibility for the intractable problems that has caused our society.

Consequently, being a bear for the right reasons does not pay. To make money in these markets you must play on the side of the criminals that run the show, the Fed and its client banks.

These banking indicators help us to understand just what they’re doing, and where the landmines might be that one day could blow this whole game to smithereens.

This brings us to a recurring theme. The first sign of potential systemic blowup would be an upside breakout in the 10 year Treasury yield. It would mean that the Fed had lost control, and that the system was careening toward an abyss from which there might be no Fed response big enough to escape.

We’ll take a look at that, but also some other problems in the banking system balance sheet that the banks and the Fed are pretending don’t exist. Well, they exist and they’re bubbling up just below the surface, to burst forth one of these days in the not too distant future.

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The Fed continues to fund roughly 85% of new Treasury issuance. It affirmed at last week’s FOMC meeting that it won’t cut QE for the foreseeable future, and it will add, if needed. That means that if the Treasury needs to borrow more, the Fed will add more QE.

But it’s now apparent that the Treasury won’t borrow more for the foreseeable future. The new stimulus bill that we now know is about to pass will cost $900 billion. But the Treasury has $1.6 trillion in cash on hand.

This has huge implications for the stock and bond markets.

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The Fed’s policy remains stable at about $170 billion per month in QE, give or take a few billion depending on the level of MBS replacements. The balance sheet is growing on trend.  The stock market is tracking with it, as usual.

This will lead to a huge problem when the economy begins to react to enlarged stimulus.

This report discusses how to position trading strategy to take advantage.

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