The key liquidity indicators outside of the Fed itself, including commercial bank and foreign central bank purchases of Treasuries and Agencies, large domestic bank trading accounts of non fixed income assets, and equity mutual fund flows all remain weak. Only net cash flowing from money funds into the banking system is still in a bullish trend, but it is on the cusp of turning bearish.
Money continues to stampede into taxable bond funds. That and Fed buying of Treasuries seems to be the only game in town. When buying is driven by a lack of suitable alternatives, it ends badly. The Fed’s money pumping appears to be the only thing keeping the market afloat. Unless these trends reverse prior to the Fed ending QE, the outlook for what comes after must remain negative.
Treasury balances at the Fed declined to dangerously low levels last week, causing the Treasury to need to float an emergency cash management bill. Treasury balances will get a boost from taxes and settlement of debt sales this week, but then will begin to fall rapidly again. TurboTax Timmy Geithner said he can avoid the debt ceiling until August 2nd, but I suspect the axe will fall sooner than that given the rapidity of Treasury drawdowns caused by below forecast revenues. Any announcement to that effect will shock the markets and be a potential contributor to a crash in both stocks and bonds.
The new and final POMO schedule calls for another $62 billion in printing with most of it ended on June 30 and just two minor operations in July with the final one on July 11. The day after could be a day of infamy—except that we know what’s coming. If our ships are still docked in the harbor, we’ll have no one to blame but ourselves. The time to take evasive action, or even to attack the enemy by going short, may have come. It’s time to be out of stocks and bonds. Unfortunately, I see no realistically safe alternatives at this time. The bigger you are, the greater your risks. Small investors holding cash at less than insured levels probably are the least disadvantaged.
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