Ezra Klein asked (and answered) in the Washington Post today, “Why are the markets down today? No reason.” What would you expect him to say? He’s a mainstream media journalist, and therefore, by definition, clueless.
I took a moment to answer his rhetorical question/answer with the real explanation (as I see it) in the comments section of his blah-g. What it boils down to, as always, is supply and demand. The item of supply in question is financial paper–in other words, debt, equity, and derivatives. Obviously, we have way too much of it, and governments and financial actors around the world, with the US Government by far the biggest offender, are supplying more and more and more of it all the time. Just as obviously, it is more than the various players in the marketplace casinos can absorb. That includes the banks, institutional and individual investors, and especially the dealers, in particular the Primary Dealers who own the casinos.
Going into the FOMC announcement yesterday, traders were hoping the Fed would pump more money into the market. And it didn’t. So they sold.
Under QE2 the Fed effectively absorbed over $100 billion a month in new Treasury supply, which was virtually all of the US Government’s new debt each month. The Fed stopped buying at the end of June. Badda bing badda boom, the stock market plunged. The dealers had to liquidate their equities inventories in order to fulfill their obligation to absorb and distribute Treasuries. The fact is that in the absence of the Fed buying a big chunk of the monthly supply, the dealers and financial markets can not absorb $100-$150 billion a month in new Treasury supply without liquidating something. That something lately has been equities and commodities. This was entirely predictable, and predicted by a number of market observers, including me, well in advance of the event.
About 6 weeks ago some on Wall Street began to speculate that the Fed would return to an aggressive program of outright Treasury purchases in support of the market. So the dealers began to accumulate stocks on weakness, betting yet again on the Greenspan/Bernanke put. Instead the Fed comes with operation Twist, which does not include one red cent of net new bond purchases by the Fed. There’s zero support there for the markets; no Bernanke put. The Fed will absorb exactly NONE of the new supply each month. 3 months ago they were taking ALL of it. That’s the only thing that kept the market levitated in the first half of the year, and even that wasn’t working very well.
With no Fed help, the guys who run the show, the Primary Dealers, now have no choice but to liquidate positions to raise cash in preparation for absorbing the next hundred billion of new Treasury paper, and the hundred billion after that and so on, until the Fed again steps into the breach.
This is the norm in the absence of massive Fed propping. We are spiraling down in terminal decline now. It will not end well.
I will have more in depth detail and analysis in a Professional Edition Treasury update tonight, to be followed by a Fed Report later this weekend. Stay tuned for all the gory details.
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