Fed QE will continue in 2020.
2019 marked the start of the Fed’s new program of QE. We refer to it by its official name of “Not QE.” Because Jerry said so. Out of deference to the central bank we have fallen in line.
The Wall Street media says the Fed started Not QE to correct a little problem in the “plumbing” of the system. That little problem has now required that the Fed add nearly a half trillion in cash to the trading accounts of the Primary Dealers. That’s for them to then disseminate into the banking system.
The Fed doesn’t tell the dealers how to do that. It just hands over the cash to the dealers when it trades with them via Permanent Open Market Operations (POMO- outright purchases), or lends it do them via Temporary Open Market Operations (TOMO- repos). The Fed then leaves it up to the dealers what to do with that cash.
They, of course, use it to do what dealers do. They trade. They accumulate inventory, attempt to mark it up, and distribute it.
No doubt another half trillion in Fed Not QE is coming in the first half of 2020 to help them do that. And a half trillion after that, and so on and so on.
The Fed has no choice. It must do QE in 2020, and for as long as we can tell.
Fed Not QE 2020 to Boost Stocks Again
The first place that Fed QE will go in 2020, like every other year, will be into the financial markets. That usually means the stock market.
The dealers, being in the business of accumulating, marking up, and distributing financial assets at higher prices (they hope), then do what they do. They accumulate the assets that are easiest to mark up. With their PR machines at CNBC, the Wall Street Journal, and Bloomberg running full blast, 24-7, that usually means stocks. But they’ve had a little problem with marking up their bond inventories. They haven’t been able to mark them up. Lately they’re losing money on them.
But since the day the Fed started Not QE, we’ve seen yet another blast of the stock market asset bubble.
Fed Not QE 2020 Intended to Do This
The Fed almost certainly had an additional intention for this half trillion in cash that it magically materialized and deposited in the trading accounts of the Primary Dealers. The first intention was to force interest rates lower. It has done that by buying $60 billion per month in T-bills out of the dealers’ inventories. It thereby removes that paper from the market. They have artificially lowered rates by adding cash to the market and by simultaneously removing supply from the market.
The Fed had to do this. Otherwise, short term rates would have gone through the roof. And so would bond yields.
In mid September, dealers and investors had exhausted their capacity to borrow short term repo money. Repos are like margin loans to buy and carry Treasuries. The dealers had essentially been financing 90% of their Treasury purchases with repo loans. They had had to, to be able to continue to absorb the average $80-100 billion per month of new debt supply that the US Government was dumping on the market.
What happened? The dealers were already stuffed to the gills with inventories of Treasuries. Those inventories had reached levels that were an order of magnitude greater than at any time in history. The dealers never had the cash to buy that paper outright. They are always leveraged to the hilt. Therefore, with more paper coming all the time, they, and other bigly leveraged players in the Treasury markets, used short term bank repo funding and other margin loans to fund those purchases.
Then somebody said, “No mas!”
Without Fed QE to help them aborb that supply, the system hit the wall and some money rates began to skyrocket.
Wall Street said, “No worries, it’s just a “plumbing” issue.”
It’s Not The “Plumbing”
This was a “plumbing” issue about as much a plumber’s crack is an issue when your septic tank is full and just can’t take any more shit.
But You’re Covered
I’ve covered the nuts and bolts of this week in and week out to some extent here since the day the Fed began its aggressive market intervention. But I’ve covered these developments in all their gory glory more regularly in my Liquidity Trader reports.
I had actually been forecasting for over a year at Liquidity Trader, that forces bearing down on the Primary Dealers would require the Fed to resume QE. And that it would do so for the very reasons that it finally did. The dealers and other players in the Treasury market hit the limit of their ability to finance and absorb the crush of supply.
The so called “plumbing” that Wall Street wants you to believe is the issue, is actually a fundamental issue of supply and demand. A leaky faucet is a plumbing issue. But so are the water mains and sewage pipes that underly your city. This is an issue of the mains and drains. There’s too much supply of Treasuries. And it is constantly increasing. And there’s not enough cash around to fund the demand to absorb it at prices that the Fed wants to maintain.
I’ve continued to document this situation in greater detail at Liquidity Trader. There, in 6-7 reports per month, I cover Fed actions in the market, Treasury supply and demand, certain conditions in the US banking system and with major foreign central banks, and the data on real time Federal tax collections and spending. These threads have created a rich tapestry. It has been a riveting, ongoing horror show, with grave implications for the future of the US markets and the US economy.
Fed Intervention Was Inevitable
Meanwhile, my charts of dealer inventories, financing, and charts of banking indicators, had made it clear that the Fed would have to intervene at some point. There was no way the market could continue to absorb the constant tsunami of Treasury supply on its own.
It couldn’t do it for the 8 years that the Fed, and its mammoth cohorts the ECB and BoJ, were doing some form of QE. During those years, the Fed and its cohorts printed enough money for the market to absorb all new Treasury supply. The Fed bought much of it outright, but it also financed the purchase of the rest. The market never had to absorb that supply on its own.
The Fed was delusional in thinking that the market could absorb this even bigger surge of Treasury supply under the expanding budget deficits of Trumponomics. Reality bit on September 17. The money market had a seizure.
The only surprise to me was how quickly the crunch came. But, having expected it, as soon the crunch hit I warned that the intervention would not be temporary, as the Fed pretended. I said that it would be permanent, and would likely mean yet another phase of the long running financial asset bubble.
The situation was far friendlier to the Fed’s policy intentions under old QE because from 2011 to 2016 Treasury supply had been steadily declining as the budget defecit shrank.
Trumponomics changed all that. The deficit surged and Treasury supply started increasing again. The deficit is again at record levels. It has leveled off in recent months as tax revenues have surged. But spending has grown so fast that there’s been no reduction in the supply of new Treasury debt. We’re looking at the Treasury adding a trillion in supply to the market per year, indefinitely. There’s just no way that the market can absorb that without the Fed’s help.
Fed Rides To the Rescue
So the Fed stepped in to the degree that it is not just helping. It has been absorbing between 85% and 90% of new Treasury supply through its straw men, the Primary Dealers. It started with a surge of over $200 billion in short term repo financing to them, and has followed with an average of $85-90 billion per month in outright purchases of T-bills, coupons, and a minor amount of additional financing.
Mostly the dealers have been just rolling over the outstanding repo, paying down some in weeks when new supply is light, but then reborrowing it when supply picks up. But most of that $85-90 billion per month over the past 2 months has been Fed outright purchases. The Fed is monetizing the Federal debt, plain and simple.
Here’s the current chart, which I update occasionally here and approximately 5-6 times per month in my Liquidity Trader reports.
Consequences Intended and Unintended
I have suggested that an intervention of this scale, with such extremes of systemic leverage would have unintended consequences, with unknown, probably uncontrollable outcomes.
The expected consequences of this were renewed asset bubbles. Stocks have seen the bulk of the benefit. But, knowing the data, we know that the Fed’s intent was primarily to support the money markets, and just as importantly, to prop up the bond market.
Fed QE 2020 Isn’t Working
The first impact, any time the Fed prints money and injects it directly into Primary Dealer trading accounts, is to foment asset bubbles. So here we are. Again.
Only it’s not working in the bond market. And that has to worry the Fed. It needs bond prices to rally along with everything else. And that is not happening. Bond prices are under pressure, and yields have been inching higher.
This key aspect of the Fed’s Not QE 2020 plan is failing. That’s what I’m watching most closely in Liquidity Trader reports. If the bond market sells off from here, the Primary Dealers will be in dire straits, just as they were in 2008. Then the system collapsed under the weight of massive debt and dealer mispositioning. We see a mirror image of that today with the dealers’ massive long positions in Treasuries and other fixed income instruments.
Here’s How To Prepare Yourself
Follow that horror story with me and be prepared for what’s coming next. If you know the facts that matter, you can protect your assets and trade what’s to come successfully.
Here’s to having 2020 vision this year! Can Liquidity Trader help you do that? Find out for yourself!
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