The Flow of Money
From Market Shadows Newsletter (11/25): From Fed, With Love.
This week, Lee Adler of the Wall Street Examiner shares his work on the flow of money between the Treasury, the Fed, Foreign Central Banks, and the financial markets. Lee’s observations provide unique and critical information for making any long-term investment decisions. Below are highlights from Lee’s Withholding Taxes Bounce Back But Treasury Supply Will Pound Market This Week.
Comments by Ilene in blue italics.
Several key bullet points:
• The Treasury announced and floated $20 billion in cash management bills (CMBs) last week. It was the third consecutive such weekly offering. $45 billion in CMBs over the past 2 weeks. It blunted the effect of the Fed’s addition of $59.5 billion in cash to Primary Dealer accounts via its forward MBS purchases.
The Treasury’s offering of CMBs to the Primary Dealers (PDs) took liquidity from the PD’s trading accounts and gave it to the Treasury, leaving less money for the PDs to buy stocks and commodities: $59.5B – 45B = $14.5B.
The $14.5 billion in cash that was not absorbed by the CMBs may have helped fuel the upturn in stocks last week.
• The next big round of Treasury supply will settle Thursday and Friday with an estimated $77 billion in new paper scheduled to settle. That should unsettle the markets late in the week, and possibly early the following week.
The market has to absorb a sum of $77B in new Treasury paper. Some of the money will come from the PDs (not all of it). Money buying treasuries will not be available to prop up stocks and commodities. $77B of supply typically requires some amount of something else to be liquidated, so there’s usually selling pressure somewhere for a couple of days right around the settlement. It can’t be completely isolated from whatever else is going on, but it tilts the playing field.
• No Fed MBS (mortgage back security) purchases are happening at this time.
The PDs will not be receiving MBS money from the Fed to offset money going to the Treasury. This should put a strain on the stock market towards the end of next week.
• Treasury supply will be light for the remainder of the month. The Fed has scheduled $70 billion in MBS purchase settlements for December 12-20, with another $10 billion or so to possibly be scheduled. That cash will set the markets up for a Santa Claus rally.
This $70B in MBS purchases will flow from the Fed to the PDs, giving the PDs liquidity to buy stocks and commodities. After the Nov. 30 $77B Treasury supply is out of the way, the MBS settlements of $70B will hit the markets. This money from the Fed to the PDs will set the market up for a rally.
• Banks and Foreign Central Banks (FCBs) have cut back in their buying of Treasuries in recent weeks, but public buying has continued at very strong levels. Without strong bank and FCB participation, the question becomes whether private investors may become the ultimate bagholders yet again.
The following chart shows that the Primary Dealers’ Treasury holdings have reached the downtrend line from their peak in June.
FCBs combined holdings of Treasuries and Agencies (GSEs) was little changed last week… The 4 week net change of total FCB holdings fell from 5.5% of new Treasury supply to 4.6%. The pre 2012 historical norm was 25%. That benchmark was normally associated with rising stock prices. Anything below that threshold signals a removal of that prop from the market, while anything higher would be a bullish factor. The Treasury market has remained bullish in spite of reduced FCB buying thanks to the increase in Primary Dealer buying until June and public buying throughout.
The FCBs are not much of a prop for the market, but private investors, both foreign and domestic, have picked up the slack. The most recent leg of the Treasury bull market has been very much a general public affair, with private investors providing most of the firepower.
• Bond Fund Flows: The ICI reports mutual fund inflows weekly with a one week lag. Net inflows into taxable bond funds were $5.4 billion in the week ended November 14, versus $6.4 billion the previous week. This remains a bullish influence, but without the strong participation of FCBs and Primary Dealers, the question becomes whether this will be enough to keep bond prices high and bond yields as low as they are.
The public has been enamored with (or being unwillingly forced into) bonds. The trend of this indicator is still bullish for bonds, but no doubt, ultimately, current buyers will be destroyed. The constant flows out of stock funds and into bond funds are reminiscent of the mid 1970s, which ultimately led to the destruction of bond fund holders in the late 1970s through 1982.
Read full newsletter: Market Shadows (11/25): From Fed, With Love.
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