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Category: Liquidity Trader – Macro Liquidity- Fed and Banking

Analysis of the major forces of macro liquidity that drive markets, including the Fed, foreign central banks, and the US and European banking systems. Resulting market strategy recommendations. Click here to subscribe. Now published at Lee Adler’s Liquidity Trader.

Look Out Bears, We May Be Headed for Excess QE

The Fed continues to fund roughly 85% of new Treasury issuance. It affirmed at last week’s FOMC meeting that it won’t cut QE for the foreseeable future, and it will add, if needed. That means that if the Treasury needs to borrow more, the Fed will add more QE.

But it’s now apparent that the Treasury won’t borrow more for the foreseeable future. The new stimulus bill that we now know is about to pass will cost $900 billion. But the Treasury has $1.6 trillion in cash on hand.

This has huge implications for the stock and bond markets.

Fed Balance Sheet Shows Bears To Float Like Butterflies, Sting Like Bees

The Fed’s policy remains stable at about $170 billion per month in QE, give or take a few billion depending on the level of MBS replacements. The balance sheet is growing on trend.  The stock market is tracking with it, as usual.

This will lead to a huge problem when the economy begins to react to enlarged stimulus.

This report discusses how to position trading strategy to take advantage.

Here’s Why More QE Won’t Be Enough for the Markets

Here’s the problem. When rates are falling, there are more sales, and especially more refi. So the prepayments go up, and the Fed sees a greater reduction in its MBS holdings. Those reductions had been running at the rate of $65-70 billion per month through last month, based on the prepayment rate in the market in prior months. The Fed then bought that much from the dealers in the following months.

Another Liquidity Indicator Shows Stocks Being Oversold – Wait, What?

In this Part 2 of the report, I cover the remaining interesting and important indicators that comprise the CLI. Each has its own story to tell, but they all lead to the same conclusion. Still bullish, and, unbelievably, one key component says that the stock market is oversold.

I find it difficult to wrap my head around that. But I won’t argue with it. If there’s one thing I’ve learned in 53 years of watching markets virtually every day, it’s not to argue with impartial indicators. They don’t care what I think should happen. They just show what is happening.

Composite Liquidity Indicator (CLI) – Shows Stocks As Oversold

Are You Kidding Me?

Can this be right? Did the stock market become oversold in mid October versus Composite Liquidity. This chart said that it did. And even after this huge 2 week rally, it’s still much closer to oversold than overbought. The S&P 500 is still near the bottom of the liquidity band.

It’s very similar to a look it had in July 2011. That preceded 4 years of a relentless, virtually unbroken bullish string.

What should cause us to expect change?

Short Term Liquidity Relief Will Turn To Big Pain

We’ve had two working theses over the past few months. One is that the Fed is no longer pumping enough cash into dealer accounts to keep an endless bull trend going. Instead, at best, there’s only enough for rotation between stocks and bonds.

The second thesis was that because dealers are so leveraged, any fall in bond prices, reflected in an increase in bond yields, would mean big trouble for the markets.

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