BREAKING: Treasury’s Latest Move and a LAMPP Update
Fed and Treasury actions this week will help to keep the Liquidity and Monetary Policy Profit indicator (LAMPP) from dropping into red territory this week. The long term LAMPP will remain Green, while the short to intermediate term LAMPPs will remain Yellow.
The Treasury has scheduled net new supply of just $5 billion in debt, an amount that the market typically absorbs easily.
Meanwhile the market gets its mid-month shot in the arm from the Fed’s regular monthly settlement of its purchases of MBS that it buys under forward contracts. These purchases replace the MBS that are paid down every month as mortgage borrowers regularly pay off mortgages each month. The Fed will settle purchases totaling $23.98 billion during the August 14-21 period.
That cash combined with the light treasury supply leaves enough excess cash for the dealers to do some buying. They have already put some of it to use this morning on the flimsy excuse that “Hey, we’re not having nuclear war yet.” Or so the mainstream media tells us. Make no mistake though, without the cash the markets would be falling and the mainstream media would be spreading a different story about why it is happening.
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This month or next month will probably see the last of these large Fed MBS settlements. I expect the Fed to announce its balance sheet “normalization” program at the September FOMC meeting. That means that reductions are likely to start in October.
For the first 3 months of the program, the Fed has said it will allow $4 billion of MBS to mature without the proceeds being reinvested in more replacement purchases. At recent purchase rates, that means that net purchases will fall to around $21 billion. The Fed will raise the cap every 3 months until it reaches $20 billion, which would reduce the monthly purchases of MBS to approximately $4-5 billion per month in one year. The reduced purchase amounts will weigh heavily on the market.
That weight will be compounded by the fact that the Fed will also be redeeming its Treasury holdings, starting at the rate of $6 billion per month, rising to $30 billion per month in 12 months. These redemptions will require the Treasury to sell additional paper to repay the Fed. That will add to already increasing levels of supply caused by structural increases in the Federal deficit.
The combination of increasing pressure from Treasury supply and reduced help from the Fed will turn the LAMPP red, possibly as soon as November-December. We will want to have sharply reduced or hedged our long exposure by then and added some shorts for downside protection and profit.
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