Liquidity measures were mixed last week. Fed pumping continues at a minimal pace and Operation Twist won’t change that. Foreign central bank buying of Treasuries and Agencies remains exceptionally weak. However, the massive deposit flows from Europe into the US system continued. In spite of that, banks continued to dump Treasuries, adding to the supply. It would seem that foreign private investors, domestic investors, speculators who are well versed in Ben’s ways, and forced short covering were driving the Treasury panic.
The market bid up bond prices in the expectation that the Fed would do the Twist. The Fed had its PR minions out for a month in advance of rubber stamping the decision on September 21. Given such speculation behind that rally and the narrowing of apparent buying support, I wrote a couple of weeks ago that it would seem that the Treasury rally may be entering its final stages.
The composite liquidity indicator upticked last week, and remains in both a short term, intermediate and long term uptrend. The growth rate has slowed dramatically since February, however, while the supply of paper absorbing liquidity, in particular Treasuries, has continued to grow at a record pace. Once the capital flight driven buying panic in Treasuries subsides, the Treasury market will reverse, and stocks may rally briefly, but ultimately, there is not enough total liquidity to support a rally in either market.
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