Facing $72 billion in new Treasury debts settling Monday, and with a little less help than usual from the Fed’s to grease the skids, the market got a haircut on Friday, and could get shave on Monday. These two days will be an interesting preview of a future without POMO aid. After Monday, the POMO will continue to flow, but the obstacle of Treasury supply will recede for awhile, so the market could sport a pretty slick looking do for the rest of the week. I’d look for an upturn on Tuesday or Wednesday heading into the end of the week. But I’d be alert for wave distortions on the news noise front, driven by any debt ceiling bowl ploppers.
The new POMO schedule is slightly reduced, running at about $22 billion a week through June 9. They’ll need to continue at roughly that rate through the end of June to complete the program. That’s when we’ll enter a brave new world. The markets need these cash pumps just to give the appearance of stability. Their absence will allow the markets’ structural instability to show itself. Instead of being delicately balanced on streams of POMO applied at just the right times, they should just topple over. But first we have 6 more weeks of the balancing act.
The POMO schedule for next week calls for only $15-22 billion in gross aid. Because $6 billion in GSE paper will mature, net POMO will total “just” $9-15 billion, so the market’s performance in light of that should give us an interesting perspective. If the market can’t hold up with $9-15 billion of support from the Fed, how will it do with none?
On the other hand, the debt ceiling issue looms, and I don’t presume to know how that will play out. It’s a contaminating factor insofar as making any judgment about the influence of reduced POMO. That needs to be resolved so that we can get back to the business of analyzing this mess in a more “pristine” environment.
Primary Dealers are handing over their long term Treasury paper to the Fed as fast as the Fed will take it, and interestingly the dealers are not replacing it. PD inventory of Treasuries is crashing. This looks like distribution. They are piling up cash at a breakneck pace. But to what end? Are they preparing for the apocalypse come the end of June, or are they preparing to buy massive amounts of Treasury paper once the Fed leaves the market. The answer to that is a no brainer, but The Street wants us to believe otherwise.
Wall Street keeps telling us that there will be plenty of buyers for Treasuries once the Fed stops POMO. All the evidence that I now see points in exactly the opposite direction. Not only are the PDs treating Treasury paper like last week’s garbage, banks in general are also dumping the stuff. Only foreign central banks have been good public servants picking up tons of the stuff in recent weeks, but even that appears to have stopped. If they go on strike, it will be a catastrophe for the market.
We might muddle through the next 6 weeks while the POMO still flows, or we might not. The front running seems to have already begun and even with plenty of POMO and a big Treasury paydown on Thursday adding even more cash to the market, last week’s teeter totter markets, suggest creeping instability. The market may look ok at times when Treasury supply is light like from Tuesday on this week, but when supply is heavy, in particular at the end of May and in mid June, the problems should be more evident.
The trends should coalesce into a crash at some point this summer, but rather than anticipate that, I’ll let the indicators show the way and signal the timing. Things could change, and a crisis that develops early, perhaps due to the debt ceiling issue, could prompt the Fed to engage in emergency action.
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