Primary Dealers were holding record levels of inventory with record levels of leverage since late Q3 2019. It was all hunky dory as long as bond prices were rising, or at least stable. The mirror of that is yields falling, or stable.
Ever since then I regularly warned about this in my Liquidity Trader reports. I said that it’s a two way street, and that when the inevitable decline in Treasury prices started, it would devolve into big margin calls to the dealers.
I have tracked these trends of dealer inventories and repo financing for years. The dealers had purchased the Treasuries almost entirely using repurchase agreements (repo) where the lenders would put up almost all the cash in return for the dealers pledging the bills, notes and bonds they bought with it as collateral for the loans.
I predicted, and this is not rocket science, obviously, that as Treasury note and bond prices fell, the lenders would demand more collateral. Duh. Those collateral calls would lead to forced liquidation in all asset classes, particularly stocks.
While these are patently obvious facts to any idiot paying attention to them–and this is where I come in–it seems that virtually no one was paying any attention to them whatsoever, outside of this one idiot.
I posited first that a breakout in the 10 year above 0.80 would signal trouble ahead. When that didn’t happen immediately, I doubled down and said, ok, well maybe the Maginot Line is 1%, but certainly the problem was there. I said that it’s just a matter of time, and not too much more time.
I’ve studied Primary Dealer bond inventory data and hedging data for many years. I knew they were exposed, but could not pinpoint an exact price level where the shit would hit the fan. That would be where their losses, and the resulting collateral calls would cause them and other leveraged holders of Treasuries, to sell stocks too.
But I knew it was inevitable, and told subscribers that month after month. I have a little OCD and am compulsive when I get an idea that flows out of my research. I just keep repeating it. Very annoying, I know. But I have to tell it like I see it.
Those things, I repeatedly warned about? We are now there. Contagion has begun.
I would not be lulled into a sense of false hope by this double bottom in the S&P fucutures. Resistance is currently (5 AM NY Time) at 3845 and 3855-60. That comes down to 3850 when New York opens at 9:30.
If they don’t clear that, the lows will break sooner rather than later. If they do manage to clear it, then a quick run back to 3890-3900 would be in order, with a pitched battle likely at that level.
Yesterday, the 10 year hit a price projection for this move of 1.60. Odds are that the selling should have maxed out yesterday, FOR THE TIME BEING. Those are based on the historical probabilities that go with this type of projection.
It’s not a guarantee that it won’t get worse. Over the long run, it probably will. In the short run, as I’ve chronicled over the last week, the US Treasury has intervened in the market. If they continue with this level of intervention it should ameliorate the situation over the next few weeks. Both bonds and stocks should rally. But ohmygawd if they don’t, it’s TEOTWAKI.
But there are more problems coming over the next several months. I’ll flesh out that scenario in a Liquidity Trader update which I should get posted later today or tomorrow. Take a risk free trial now and don’t miss a beat. You can also access all past reports.
To post your observations, and snide, but good-natured, comments, click here to register. Be sure to respond to the confirmation email which is sent instantly. If not in your inbox, check your spam filter.
Meanwhile, here’s some free stuff I’ve written about this unfolding catastrophe.
Wall Street Examiner Disclosure: Lee Adler, The Wall Street Examiner reposts third party content with the permission of the publisher. The opinions expressed in these reposts are not those of the Wall Street Examiner or Lee Adler, unless authored by me, under my byline. I curate posts here on the basis of whether they represent an interesting and logical point of view, that may or may not agree with my own views. Some of the content includes the original publisher's promotional messages. No endorsement of such content is either expressed or implied by posting the content. All items published here are matters of information and opinion, and are neither intended as, nor should you construe it as, individual investment advice. Do your own due diligence when considering the offerings of information providers, or considering any investment.