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.

Support the Wall Street Examiner! Choose your level of support to receive a free proprietary report as my thanks. Click the button below to see your options. Become a Patron!

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.

Mr. Minuschin’s Erection To Boost The Election

We have known for a couple of months that there would be a mountain of Treasury supply hitting the market at the end of September. We also knew that Fed QE would be far from adequate to absorb this supply. So I have expected something bearish for stocks at the end of September. This could spill over into the first week of October.

But then things get hairy for bears, with potentially happy days for bulls. Unfortunately, we have a little problem this week. There’s no visibility. We don’t know what they have planned for the next couple weeks. That’s different from usual, where we can usually see ahead for a week or two because we know the Fed’s QE schedule, and also pretty much know how much Treasury supply to expect.

Now, thanks to the exigencies of the past pandemiconomic US Treasury fund raising back in March and April, we don’t have that luxury on Treasury supply, which forces us to surmise some things.

Here they are.

Macro Liquidity Rising But Other Issues Intrude

Composite liquidity continues to rise, but at a slower pace than in the second quarter as the Fed has slowed QE. That reduces the cash flowing into Primary Dealer accounts, which in turn contributes to a slowing in secondary liquidity drivers.

“Slowing” is a relative word, however. Historically, the numbers remain gargantuan.

No, something else is holding the market back. Here’s what that something is, and what we’re going to do about it.

Market Dough Gets Punched Down

Surprise, surprise! They pumped the money in but the market didn’t rise.

The Fed has been in the process of pumping $88 billion into Primary Dealer accounts this week in the form of its regular monthly MBS purchase settlements. Most of it is done. $22.7 billion of it will settle on Monday September 21. That will be the last MBS settlement until October 14-21.

Meanwhile, the Fed continues to purchase and settle Treasuries virtually every day. Over the past week that’s amounted to a total of about $37 billion. That means that a total of $103 billion in QE settled this week. That’s how much cash the Fed pumped into Primary Dealer accounts.

It didn’t matter. The stock market sucked gas. Bonds treaded water. It sure looks as though the Fed has somehow managed to magically peg bond yields just below 0.80% on the 10 year. The Treasury issued $104 billion in new coupon paper over the past week and that didn’t depress the market? It’s a miracle.

But isn’t it strange that the amount of QE and the amount of Treasury coupon issuance was virtually the same.

Uh… No.

But some other stuff sure as heck is, and you need to know about it.