Falling Interest Rates Illusion Leads Wall Street to Dangerous Wrong Conclusion

Short term interest rates have fallen sharply in recent weeks. Wall Street says that falling interest rates mean the economy is weak. Therefore the Fed will cut rates in July, and perhaps several more times this year. 

But the Street is wrong. Here’s why, and here’s what the problem is for investors.

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Since early May, the Treasury has paid down $118 billion in outstanding T-bills. That removes that paper from the market. It also pumps cash back into the accounts of the dealers and institutions who had held the expiring bills.

Those dealers and institutions are suddenly loaded with extra cash that they have to put somewhere. But they are now faced with a shortage of paper in which to reinvest, since the Treasury has removed so much of it from the market. So the dealers and institutions bid more aggressively on existing paper in the market. That pushes rates and yields down on Treasuries all along the yield curve. It also pushes down yields on corporate paper, including funky junk. As a result we’ve had a massive rally in all kinds of credit instruments.

The 13 week T-bill is a perfect illustration.

Falling Interest Rates

Falling Interest Rates Create Dangerous Illusion

With market rates falling across the yield curve, Wall Street talking heads have concluded that the economy must be weakening, and that the Fed will cut rates.

The premise is false however. Rates are falling not because the economy is weak, but because the debt ceiling is holding back new issuance. The debt ceiling is forcing the Treasury to pay down short term paper. Those paydowns inject cash into the markets. It creates an illusion that leads traders and investors to the wrong conclusion, the conclusion that the economy is weakening and that the Fed must cut rates.

Anyone who has bet on that conclusion will pay a heavy price when the Treasury comes back into the market. We looked at the rate at which the government is depleting its cash in the Federal Revenues report last week. It looks like the Treasury will run out of cash and will need to come back to the market in August or September. The Treasury must then borrow hundreds of billions of dollars to repay the internal funds that it raided to pay down debt and keep paying its expenses.

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Lee Adler

I’ve been publishing The Wall Street Examiner and its predecessor since October 2000. I also publish LiquidityTrader.com, and was lead analyst for Sure Money Investor. I developed David Stockman's Contra Corner for Mr. Stockman. I’ve had a wide variety of finance related jobs since 1972, including a stint on Wall Street in both analytical and sales capacities. Prior to starting the Wall Street Examiner I worked as a commercial real estate appraiser in Florida for 15 years. I also worked in the residential mortgage and real estate businesses in parts of the 1970s and 80s. I have been charting stocks and markets and doing analytical work since I was a teenager. My perspective is not of the Ivory Tower. It is from having my boots on the ground and in the trenches of the industries that I analyze and write about today. 

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