Thank the Fed’s Not QE program, and light Treasury supply! Supply and demand conditions for stocks and bonds have been as good as it gets over the past month [as of January 23].
This post is excerpted from the Liquidity Trader report originally posted on January 23. Get these reports 6-8 times per month in real time. Sign up for your risk free trial right now!
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The Fed continues to pump massive amounts of cash into Primary Dealer trading accounts. At the same time, Treasury supply had its usual seasonal reduction from mid December to late January. That happens because quarterly corporate taxes flow into the Treasury on December 15 and individual estimated taxes come rolling in on January 15. So the Treasury has some extra cash for a few weeks.
New debt issuance slows, and the Treasury may even pay down some debt in some weeks. This is one of those weeks. Between December 17 and January 27 the government will have issued “just” $25 billion in net new debt. Meanwhile, the Fed pumped $67 billion in cash into dealer trading accounts over the past month.
Fed Not QE Means Too Much Money, Not Enough Inventory – Temporarily
Now let’s see. The dealers had $67 billion in new cash, but the Treasury only issued $25 billion in new debt. Do the math! Even if the dealers are tasked with absorbing every penny of new Treasury debt, which they most certainly are not, they’d still have $42 billion left over. That’s play time for them. $42 billion will buy a lot of stuff at the margin, every time. So the dealers did buy bonds this month, and of course they bought stocks just like they always do. For them, that’s the easiest markup game in town.
With all that cash, the Treasury market pulled back from the brink. I had pegged the 1.90 area as the line that shall not be broken. Otherwise, the bond market could melt down. Sure enough, they got there in late December, toyed with a break, but then the dealers, flush with cash, did what they needed to do to stave off disaster for yet another day.
January is an easy month for the market because individual quarterly estimated taxes are paid on January 15. This cash reduces the government’s borrowing needs in the second half of January. However, the going gets a little tougher over the next week [January 24-31], as the government issues $33 billion in net new debt.
Dealers Are Flush With Cash Because the Fed is Still Buying
No worries though. The Fed is buying virtually all of it, through its strawmen, the Primary Dealers, under its Not QE program.
That program has actually shrunk a bit over the past week as the dealers paid off some of the repo loans they had taken. That’s because the Treasury has no issuance scheduled January 17-28. In fact, it is paying down $5 billion in outstanding bills this week. So the dealers don’t need any more cash at the moment.
Regardless, the Fed keeps cashing them out, buying $13 billion in Treasuries from them already this week [through January 23].
And guess what! Because they didn’t need it, they lent it back to the Fed in reverse repos (RRPs), and the Fed pays them interest on that! RRPs outstanding were near zero on January 15. That’s where they’ve been most of the time since the Treasury absorbed all excess cash in the system last summer. But this week, RRPs jumped to $13 billion, exactly the amount of cash that the Treasury put back into the system via its bill paydowns. That will go away when the Treasury resumes new issuance next week.[Ed. Note: Sure enough, RRPs outstanding went to absolute zero a day later and are now at .002. The Fed has pumped a half trillion dollars into the financial system since mid September — over a hundred billion a month — and nobody has a dime left over to lend back to the Fed!]
Think of it. The Fed gives the dealers around $80 billion a month via Treasury purchases, and then it pays them interest on the money it just gave them. What a racket.
Plus, it will effectively lend the dealers as much additional cash as they want through the repo lending program.
Total repos (Temporary Open Market Operations- TOMO) outstanding under Not QE now stand at $205 billion. Total permanent purchases since the start date of the program have risen to $288 billion. That brings total Not QE to $493 billion.
That’s been enough to absorb 87% of Federal debt issuance over that period. Notice the railroad tracks on the chart below between total Federal debt issuance (orange line) and total Not QE (gold line). They’re moving virtually in lockstep.
I’ll say it again. This is outright debt monetization. The Fed really has no choice if it wants to suppress market interest rates. It must buy virtually all the paper the government issues. If it didn’t, bill rates and bond yields would soar, taking all interest rates with them.
Meanwhile, the Fed is buying, and the Treasury isn’t selling as much. Conditions just don’t get more bullish than this. We’ve had light Treasury issuance since mid December corporate tax collections, and mid January individual estimated tax collections. All the while, the Fed continues to pump massive amounts of cash into dealer trading accounts.
So it’s no surprise that bonds have rallied. The only surprise is that they haven’t rallied even more.
The Dealer Markup Game Has Never Been Easier
Thanks to all this cash stuffed into dealer accounts, they can keep pushing stocks to new all time highs. The dealers love stocks, because stocks love them back. Using CNBC and the Wall Street Journal as PR and marketing venues, the dealers are able to easily manipulate their institutional customer bases into buying stocks at ever higher prices.
Their business of accumulating, marking up, and distributing stocks has never been easier. It’s a game that everybody loves to play. Think blackjack, with the Fed providing a never ending supply of chips.
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