A couple of minor technical problems called “business” and “life” have now intruded on my increasingly bogged down publication schedule that, in the interest of getting caught up, I’m presenting a condensed version of the Fed Report tonight. It includes just the main components of the macro liquidity indicator (which I suspect is probably all that you really want anyway). For reference purposes you can access the last full report and a free preview here. I promise to do my best to get back to the usual 125 page tome by the end of this week. Then I will take a vacation!

In the meantime, I thank you for your forebearance and support. My 90 year old mother and my wife, who rarely see me, both thank you for sharing me with them from time to time.

I hope that you are enjoying the new Capitalstool.com Stool Pigeons Wire message board software also installed at the Wall Street Examiner forums, that I have been working to get installed and operational since yesterday. They’re pretty spiffy and were part of the reason for this delay, but only part.

So, with no more excuses and without further adieu, let’s begin this week’s festivities on a fresh page. However, before we do that, I would like to note just one thing that’s not covered in the summary report below. The Fed’s balance sheet shrank by $10 billion this week and is now $45 billion below its level when QE2 ended last June. So please don’t get sucked in by the nonsense flying around the web about the Fed doing a stealth QE. It just ain’t a fact, M’am!

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The Treasury had a light calendar last week. The market faced a big Treasury settlement on Tuesday but from then until the big end of month settlement of new paper, supply pressure wasn’t, and won’t be, a problem. With fear driving waves of capital into the Treasuries, a downside breakout in yields, and an upside breakout in the dollar look eminently doable, if not likely. So what is the problem? As Treasuries seemingly suck up all available capital in a worldwide buying panic, the flip side of that coin is a worldwide selling panic in everything else, including equities.

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The composite liquidity indicator downticked last week on small declines in most of its components. We know that the downtick in the Fed’s pumping to Primary Dealers is temporary, but the weakening in other indicators may not be. Over the course of this latest surge, most of the cash has been targeted at the Treasury market, with stocks getting only an occasional bid. As Treasury supply goes through its seasonal increase, the pace of the advance in Treasuries should materially slow. If the indicator stalls, then both stocks and bonds could be weak. As long as the indicator remains in an uptrend however, Treasuries should continue to rally, and stocks should at least get an intermittent bid.

The following is an extended excerpt from the Primary Dealers section of the report. Subscribers click here to download complete report in pdf format.

Primary dealers’ fixed income holdings dropped sharply in the week ended 5/2/12 (reported with a one week lag), after a big increase the week before. When they start reducing those positions that should signal a more persistent rise in yields. They continue to reduce their positions in corporates, a downtrend that has been under way since October 2007 (chart, page 52).

Primary Dealer Holdings- Click to view

Primary Dealer Holdings of Corporate Bonds - Click to view

Primary Dealers sold some of their big Treasury long position in the week ended May 2, (reported with a one week lag). Based on the long term chart of the 10 year yield (next page), Treasuries remain at an extreme level of extension from the trend. This looks like a distribution pattern, similar to the one in early 2003.

Primary Dealer Holdings- Click to view

The dealers are still getting a lot of help from European capital flight and heavy public buying so as long as they maintain their positions at this level, yields should stay low and bond prices high. When this pattern breaks (chart below) is when yields are likely to start trending higher.

Commercial bank (including foreign based US branches) trading accounts grew by $1.0 billion in the week ended May 2 (after revisions). The short term and intermediate trends of this indicator are now neutral. This indicator is included in the liquidity composite.

Bank Trading Accounts - Click to enlarge

The Fed settled no MBS purchases in the week ended May 9. At the same time, purchases and sales under Operation Twist were slightly offset resulting in a small net sale that was not material and will be quickly reversed. The dealers no longer have the benefit of the huge Treasury paydown windfall that they had in mid April. They will suffer the opposite, with increasing levels of new Treasury supply to absorb. That will mute the bullish effects of the Fed purchases of MBS.

There should be a large settlement this week. It may already have occurred or be under way and it is probably part of the reason Treasuries have been so strong for the past couple of days. It is no accident that the Fed schedules these big settlements coincident with the settlements of the 10 year and 30 year bond auctions. This could give stocks a little boost later this week.

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The Treasury had a heavy calendar this week, but the new supply won’t settle until May 15. After Tuesday, Treasury supply will not pressure the market until the end of month settlement of notes and bonds. But the market has other problems and they are big ones. This 2 part report examines key forces that impact US stock and bond prices each week. The Treasury part focuses on those directly affecting the Treasury market, with an eye to their impact on stocks. (Subscribers click here to download complete report in pdf format.) The second part, focusing on the Fed and the macro forces of liquidity will follow on Monday.

The Treasury will continue to benefit from instability in Europe. Clearly there are more defaults in our future. European investors and depositors will continue to flee their banking system for the apparent “safety” of the US. The JPM situation will raise additional fears. That will keep Treasury yields suppressed for a few more months. The short term technical target on the 10 year is now 1.68. That should continue to correlate with a bearish trend in stocks and it may or may not be the last word. It is difficult to forecast just how low yields will go in the final blowoff of the Last Ponzi Game Standing, the US Treasury market.

Tax receipts dropped sharply after the end of the 2011 collections on April 17. Withholding is back to just about even with last year in real terms. This suggests that the economy has stalled again. If this persists, it will spell bigger than expected Treasury supply. Apparently stocks would take the brunt of the pain that would inflict.

The Primary Dealers continue to maintain near record positions in longer term Treasuries. It’s unclear how much more support they can give the market from here. Their positions as well as long term cycle indicators are at record extensions. They’re likely to be distributing into the current buying wave. When they start reducing that record long position, that should be the signal that the bond bull market is ending.

There’s no sign of lessening institutional demand in the Treasury auction data, although banks are buying less as they become more capital constrained. The JPM situation will not help in that regard. Meanwhile the public, as represented by bond mutual fund flows, is still buying bonds like mad. This is part of Dr. Bernankenstein’s soulless and evil grand plan to force people to speculate and reach for yield, in a vain attempt to push the price of financial assets higher. The theory is that this will trickle down to the economy. We know that this policy is doomed, and in many ways counterproductive right now. People who spend their capital down to zero can no longer spend.

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The composite liquidity indicator rose slightly last week, on slight increases on most of its components. The uptrend in the indicator has continued at a steady pace since it broke out in March. Over the course of this latest surge, most of the cash has been targeted at the Treasury market, with stocks getting only an occasional bid. As Treasury supply goes through its seasonal increase, the pace of the advance in Treasuries should materially slow, but until the forces of liquidity at least level out, both markets are likely to remain intermittently buoyant.

Just how buoyant will depend on a few factors.

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Assuming the 4 week bill offering again totals $30 billion, the market will have a paydown of $2 billion on Thursday, so even though there’s a big calendar, the impact won’t be felt until the following week when the buyers of the paper have to think about how to pay for it. Supply won’t rear its ugly head this week, so stocks should bounce back, at least a little. On the other hand, fear is good for the Treasury market, so expect some bad news early in the week until the Treasury has had the opportunity to unload at least the 3 and 10 year notes.  It’s off to a good start Sunday night on the European election headlines. European investors are looking forward to more defaults and are getting the hell out of Dodge.

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This is an extended free excerpt from the Professional Edition Fed Report.

The composite liquidity indicator rose slightly last week, on a mixed performance of its components. The uptrend in the indicator has continued at a steady pace since it broke out in March. Over the course of this latest surge, most of the cash has been targeted at the Treasury market but in the past week, stocks have seen renewed interest. As Treasury supply goes through its seasonal increase, the pace of the advances in both markets should materially slow, but until the forces of liquidity at least level out, both markets are likely to remain buoyant. Just how buoyant may largely depend on two factors.

First, the Fed will have to decide how to extend its bond purchases in June when the MBS program expires. It must engage in some form of program in order to offset the natural shrinkage of its balance sheet from maturities of Treasuries and GSE paper, and from MBS paydowns. If it simply extends the current program, that will suggest a continuation of modest and irregular advances in stock prices, coupled with a rangebound bond market. The Fed however, may decide to expand the program, buy MBS outright, or buy Treasuries or GSE paper outright. Depending on the amounts, such programs could have more bullish impacts under ideal conditions where commodities cooperate.

That’s not likely. The signs of resurgence in commodities make any expansion of the Fed’s bond buying problematic. The stronger commodities are, the more the Fed’s hands will be tied. I believe that the Fed is already behind the curve due to its focus on lagging and artificially understated measures of core inflation. This problem will at some point hit the market with an “unexpected” upside CPI surprise. If the economic data is reasonably firm, commodity prices are rising, and core inflation measures start to catch up with reality, that’s when the markets will need to face the fact that the central bank gravy train must end.

My sense is that this will happen within 6-12 months. We need to be alert for the underlying signs, and for noises out of the Fed to that effect. As an increasing number of Fedheads start to wring their hands about inflation, and Bernanke’s ventriloquist dummy, Jon Hilsenrath, start to write stories about it in the Wall Street Journal, that’s when we’ll know that the times, they are a changin’.

The longer term direction of the liquidity composite indicator would suggest that the stock market should continue to have a bullish tilt, while Treasuries, which are over-owned and still long term overbought, may get hammered intermittently in spite of the desire of the US Government, the Fed, and the dealers to suppress yields. We will have to rely on the technical signals in both markets, as reported in the Professional Edition Daily Market Updates and weekly Treasury updates to tell the story of whether the liquidity tide is flowing into, or out of those markets.

This report shows the charts of the 7 key components of the composite liquidity that drives the markets, and more than a dozen other charts and tables with clear, concise explanations of those forces that drive and influence markets and policy maker responses. If we are to grasp what the future may hold, we must first have a clear understanding of the present.

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Stay up to date with the machinations of the Fed, Treasury, Primary Dealers and foreign central banks in the US market, along with regular updates of the US housing market, in the Fed Report in the Professional Edition, Money Liquidity, and Real Estate Package. Try it risk free for 30 days. Don’t miss another day. Get the research and analysis you need to understand these critical forces. Be prepared. Stay ahead of the herd. Click this link and begin your risk free trial NOW!

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The market update will be posted on Tuesday morning at approximately 8:30 AM NY time.  The Precious Metals Update will be posted at approximately 9:15 AM. The Fed Report will be posted Tuesday evening.  See you then!

Extended free summary excerpt

The massive $50 billion Treasury bill paydown that the dealers and other holders received on April 16, augmented by a much more modest $3 billion paydown last week was enough to keep the markets floating upward on a sea of cash. But the tide is about to go out.

Monday, the players must settle $54 billion in new notes and TIPS auctioned last week. From now until mid June, when estimated quarterly income taxes will be collected, there will be no more paydowns. Every other week, another wave of longer term paper will buffet the market. This is a normal feature of the calendar every year, which is one of the reasons why “sell in May and go away” works so well year in and year out.

Last year the Fed exacerbated the problem by taking a wait and see attitude after QE2 wound up. Ben will not make the same mistake this year.

The public, as indicated by bond mutual fund flows, is still buying bonds like mad. By holding short term rates at zero, Bernanke is forcing old people to take ever increasing duration and credit risk. The first wave of Bernankecide through the forced drawdown of savings accounts and money market funds will be followed by a second wave when the elderly face massive capital losses in their bond mutual funds. This massive ongoing loss of purchasing power is a drag on the economy. Bernanke has never addressed the issue because the question hasn’t been asked exactly in those terms.

Tax receipts through mid April were much stronger than last year, but that party appears to be over. Tax receipts have fallen rapidly over the past 10 days, so that they are now barely above last year’s pace in real terms. I may be jumping the gun, but if this continues it will indicate that the economy has stalled again. That will spell bigger than expected Treasury supply.

Click here to download complete report in pdf format (Professional Edition Subscribers) including 28 pages of charts and clear, cutting edge analysis that you can use to gain an edge in the market. Try the Professional Edition risk free for thirty days. If, within that time, you don’t find the information useful, I will give you a full refund. It’s that simple. 30 day risk free trial for new subscribers. Click here for more information.

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Stay up to date with the machinations of the Fed, Treasury, Primary Dealers and foreign central banks in the US market, along with regular updates of the US housing market, in the Fed Report in the Professional Edition, Money Liquidity, and Real Estate Package. Try it risk free for 30 days. Don’t miss another day. Get the research and analysis you need to understand these critical forces. Be prepared. Stay ahead of the herd. Click this link and begin your risk free trial NOW!

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This is an extended excerpt from the Professional Edition Fed Report Executive Summary.

Note: Pages 4-10 comments correctly updated at 3:55 PM NY time.

The composite liquidity indicator rose sharply last week, driven by a big Fed settlement of MBS purchases. The uptrend in the indicator is accelerating. Over the course of this latest surge, most of the benefit of this increase in liquidity has been targeted at the Treasury market.

As the Primary Dealers try to keep yields as low as possible on behalf of their primary client, the US Government, they are also giving themselves time to distribute their unusually large long positions, most of which were acquired near or above current prices. That run to 2.40 on the 10 year a month ago was an intolerable situation for them at the time. Now that they’ve put themselves in position to work off some of the inventory at better prices, at some point they will want to stand aside from taking on so much Treasury inventory and focus elsewhere. As a result, both bond and stock prices could face crucial inflection points in the weeks ahead. But in the short run, another parabolic buying panic in bonds is under way.

I would expect the liquidity indicator to develop a negative divergence before the stock market tops out ahead of the next major cyclical bear market. So I suspect that the recent stock market malaise is just a matter of the market owners, mostly Primary Dealers, shaking the stock market tree to benefit their Treasury positions, and their biggest client’s absolute necessity of keeping its borrowing costs as low as possible. In weeks such as this one when the government must roll over a huge amount of long term paper, not to mention adding new paper to that pile, the focus will always be on funneling available liquidity toward that purpose, thus keeping the government’s borrowing costs low. The market’s managers are off to a strong start this week as the first auction of intermediate term paper gets under way on Tuesday.

The Treasury rally is also partly due to the $50 billion in paydowns that came back to holders of short term Treasury paper last Thursday. Many of those holders were Primary Dealers. They took the cash and used it to squeeze the Treasury shorts while other investors who were flush with this cash simply panicked into buying longer duration paper because there weren’t $50 billion of bills available to absorb the cash.

This is a short term situation that should burn itself out within a few days. After this, the next Treasury paydown won’t be until mid June. There will be lots of new supply and not quite as much cash until then, so I do not expect this move in Treasuries to result in yields dropping significantly below the levels reached by last September, if at all.

In those alternate weeks where Treasury supply is confined to short term bills, the dealers usually find reasons to support stocks while they let yields drift up a bit. That process could start once this week’s auctions are out of the way on Thursday.

Click here to download complete report in pdf format (Professional Edition Subscribers) including 106 pages of charts and clear, cutting edge analysis that you can use to gain an edge in the market. Try the Professional Edition risk free for thirty days. If, within that time, you don’t find the information useful, I will give you a full refund. It’s that simple. 30 day risk free trial for new subscribers. Click here for more information.

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Stay up to date with the machinations of the Fed, Treasury, Primary Dealers and foreign central banks in the US market, along with regular updates of the US housing market, in the Fed Report in the Professional Edition, Money Liquidity, and Real Estate Package. Try it risk free for 30 days. Don’t miss another day. Get the research and analysis you need to understand these critical forces. Be prepared. Stay ahead of the herd. Click this link and begin your risk free trial NOW!

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