There’s a Fed meeting this week. Will we see actual follow through on all those Valentines the Fed’s talking heads sent to the stock market the past couple of weeks?
Spooked by the December selloff, former tough guy, Chairman Pow! has morphed into Mr. Milquetoast lately. He and his minions have been tossing love bouquets at the market, whispering sweet nothings about pausing rates, talking about slowing the pace at which it shrinks its asset holdings, and talking about maybe even ending the balance sheet “normalization” program early.
The bouquets were designed to stop the selloff. They certainly helped. Trump and Treasury Secretary Mnuchin didn’t hurt things by making it appear that the Trump regime also had the market’s back.
In a way, it did. And we saw the results.
Here’s what happened, what’s going to happen, and what to do about it.
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The Real Reason for the Rally Wasn’t Talk, It Was Money
As you know by now if you’ve been following Sure Money, I thought that the real reason for the rally was the excess cash that the US Treasury accrued because of the government shutdown. It used that money to pay down billions in outstanding short term Treasury bills. The holders of those bills couldn’t roll them over. The Treasury redeemed them and the holders got cash instead.
Some of them plowed that cash right into the stock market. They had decided that it was time to go back to “risk-on.”
With the Shutdown Ended The Bills Now Come Due
I thought that the shutdown would drag on. I was wrong about that. This weekend, the boss caved and re-opened the government. He says it’s temporary if the House Democrats don’t bend. We’ll see. I have no idea how that will play out. Sooner or later the government will stay open. The government will need to spend a big slug of money to catch up on what it owes, and then it will keep spending.
It has two choices on how to pay for it. It can spend it out of the $400 billion cash hoard it has built up since 2016. That would entail no new debt offerings. Or it can go back into the market to borrow it.
With the contingencies of another possible GSD and the end of the debt ceiling suspension in March, they’ll probably decide to hold on to their cash. They would therefore need to go into the market to raise the funds that they didn’t raise last month.
That will be on top of what is always a YOOGE borrowing schedule in February. February is when the biggest wad of tax refunds goes out. If the Treasury decides to borrow that extra cash on top of the usual heavy February borrowing, it will be a tough haul for stocks and bonds.
On the other hand, holders of Treasury bills, which hopefully includes you, will get a nice bonus, because bill rates will resume their rise, regardless of what the Fed says about pausing rates. It’s a simple matter of supply and demand. The supply of T-bills will increase, and the demand for them will fall short of being enough to absorb all that paper without rates rising.
We saw what resulted from that dynamic before. It was a straight line trend of rising interest rates, regardless of what the Fed said or did in any given month.
The pressure on the money markets was relentless until the GSD. That pressure came from the Treasury pounding the market with supply at the same time as the Fed was pulling $50 billion per month out of the banking system. Even the massive liquidation of stocks in December did not generate enough cash to reverse the rise in short term T-bill rates.
Rates Are About To Skyrocket Again Despite Fed Words
But then came the GSD, and the paydowns of $47 billion in outstanding T-bills. That put cash back in the accounts of the erstwhile holders of the bills, while simultaneously removing bill supply from the market. So rates have backed off a few basis points in recent weeks. And I mean, a few! It hardly registers on the chart.
That dynamic ends now with the suspension of the GSD, unless the Treasury elects to instead spend its cash to pay the buildup of past due payments.
We simply must watch the Treasury’s cash balance and bill issuance announcements day to day to see how they decide to handle this. If they boost new bill issuance as I believe is more likely, opposed to spending down that big pile of cash, then rates should start moving up again.
The Fed is the new wildcard. Chairman Pow! has now abandoned his stance as the tough hombre who repeatedly said that the balance sheet bloodletting was on autopilot. Like an idiot, I believed him. After following the Fed for as long as I have, shame on me! In recent weeks the Fed is spewing declarations of love to the markets from all of its offices.
Frankly, my dears, I don’t give a damn what they do. Unless they start QE again. Cutting the bloodletting rate to something less than $50 billion per month, or even ending it altogether, will only lower the slope of the rise in rates. It won’t reverse it. To stop rates from rising, the Fed would need to return to QE, injecting enough cash into Primary Dealer accounts to enable the absorption of the bulk of new Treasury supply, with enough cash left over to drive down rates.
That’s not on the horizon.
If the Fed really does soften policy rather than just give lip service, then the route of rate increases, the rise in bond yields, and the decline in stock prices, will be bouncier and more circuitous. But the general direction will not change. Interest rates and bond yields will trend higher, and stock prices will trend lower.
Just be ready for huge rallies like the present one to interrupt this trend regularly. Trading it successfully will require attention to market timing and good trade management principles. Here’s somebody that can help you with that.
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