Treasury supply continues to bulge, thanks to the yawning Federal budget deficit, and the fact that the Treasury must raise $30 billion per month to repay the Fed.
That’s because, under its program to shrink its balance sheet, the Fed is demanding that the US Treasury pay the money back that the Fed lent to the US Government under QE.
On top of that, the federal budget deficit will top a trillion dollars in the 12 months since the new tax law and spending increases took effect.
The soaring deficit has been steroids for the US economy, but the government must borrow that money before it can spend it. That means that a trillion dollars a year is now hitting, and will continue to hit the market in massive quarterly waves for years. And the money isn’t there to absorb it without prices falling drastically. That means lower stock and bond prices and higher bond yields.
Right now we are right in the early stages of one of those waves, and it will decimate stocks and bonds.
Treasury Supply Broke the Dam. Now Wait As These Floodgates Open
I had pointed out in August that the amount of new supply hitting the market has been breathtaking, higher than even budget experts at the nonpartisan Congressional Budget Office (CBO) or Joint Committee on Taxation (JCT) anticipated when the tax cut and BBA were passed early this year.
The media picked up that theme in September.
The Treasury Borrowing Advisory Committee (TBAC) supply forecast for Q4 issued in August was another warning of a coming tsunami of supply.
On October 15, the Trump Regime confirmed all of those warnings when it announced that the fiscal year 2018 budget deficit had blown out to $779 billion, with the tax cut and Budget Busting Agreement impacting only the last 8 months of that period. For the first 4 months of the fiscal year, tax revenues were higher, at the old higher rates, and spending was less than now.
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For the first full calendar year after those two laws were went into effect, we can expect the deficit to exceed a trillion dollars. That means an average of $80-90 billion per month in new Treasury supply.
But it does not come at an even pace. It varies widely depending on quarterly estimated income tax collections. One of those just passed on September 15. That quarterly cash windfall resulted in a few weeks of debt paydowns that helped the stock and bond markets for at the end of September. Investor bullishness went through the roof as a result.
But then, this month the dam broke as Treasury supply returned to the market in a huge wave in the first two weeks of October. The markets were not able to smoothly absorb that onslaught of supply. That onslaught will continue as tax collections will be seasonally weak until the next quarterly tax due date in mid-January. Until then, a gargantuan wave of supply is coming that will repeatedly buffet the markets.
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Despite Intermittent Rallies, These Factors Made the October Stock Plunge No Accident
Indeed, we have seen repeated intermittent rallies in stocks and bonds. I have covered in past reports how traders increased their borrowing to buy stocks. The increase in financial leverage is hugely dangerous because there’s very little cash cushion to absorb shocks, and the Fed is working to deflate even that.
I have also reported how pension funds made big investments to take advantage of a tax break, under the new tax law, that expired on September 14. It was an esoteric, not widely known feature of the new tax law.
Shortly thereafter, the Wall Street Journal and other media outlets picked up the pension fund story.
It’s a critical factor, because that artificial buying prop is now gone. In fact, we’re facing a demand vacuum from pension funds. With pension fund purchases brought forward from the future to take advantage of the tax break, those funds will do far less buying of both Treasuries and stocks than normal for the next several months. The early October stock market plunge was no accident in that context.
We also know that stock buybacks on the heels of the corporate tax break for repatriating foreign profits played a big role in the first and second quarters. It may have continued to do so at a lesser pace as time has gone on.
Again, that will have diminishing returns as the wave of repatriation after the passage of the massive corporate tax boondoggle subsides. These one shot deals inflated stock prices. With Wall Street cheerleading from the sidelines, the public was hooked into believing that the market would never face a reckoning.
But the question now is who will step in to replace that one shot of buying. The answer is no one.