I’m not concerned about trying to get ahead of the Fed because, when it comes to the market trend, money talks and Fedtalk walks. The Fed’s manipulative chatter and the media’s interpretation of it can only move the market in the short run. The market may get knocked off course for a few weeks, or even a couple of months, but it always returns to the trend in forceuntil a material change in monetary policy has been implemented. If the trend of money availability is declining, then the market will decline.
The long term direction of liquidity is still down, the big blip in December notwithstanding. That blip was only created because there was so much selling, which drove stock prices into the ditch from which they have only partly recovered. As we saw in Part 1 of this post, that selling caused the buildup of a huge pile of cash in the accounts of market participants, and that fomented the current rally.
That big selloff in December was a gut check for the Fed. It made the central bankers start thinking about slowing the rate at which they take money out of the banking system by redeeming the Fed’s holdings of Treasury securities and MBS. That program has been on autopilot, lately at $50 billion per month. But having been gut punched by the market, Powell and his cohorts have now changed their tune.
Did the Fed Really Just Realize that “Normalization” Would Be A Pain?
I find it amazing and only half believable that the Fed did not realize that “normalizing” the balance sheet would cripple the market.
Back when Bernanke was running the show, I thought that he created this gargantuan monster balance sheet specifically so that the Fed never would even think about reducing it. He wanted to flood the market with permanent liquidity and tie any future Fed’s hands. It was seemed to me that Bernanke knew that the Fed could not reverse QE without tremendous disruptions to the markets, including much higher bond yields and lower stock prices.
When the Yellen Fed started floating trial balloons about “normalizing” the balance sheet in 2016, more than a year before they actually started, I realized that they were serious, and I began to warn about the effects of the policy. Again, if you’ve been around Sure Money for a while, you’re familiar with those warnings and the rationale behind them.
Since the Yellen Fed first ended QE in late 2014, and started floating trial balloons about “normalization” in 2016, we’ve had a big bear market in bonds, which has had a countertrend rally in the past 2 months. Then in 2018 we saw the start of a bear market in stocks, now undergoing its own countertrend rally.
Talking About It and Doing It Are Not the Same
The Fed ruminating about a policy change and actually doing it are not the same thing, however. While the Fed is “thinking” about possibly slowing the pace of its draining operations, it’s still sucking $50 billion per month out of the banking system. It’s doing that as the Treasury needs to sell an average of at least $100 billion per month in new debt paper. It’s a double whammy for the markets.
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Over the past couple of weeks the markets have been awash in short term cash (see Part 1 of this report.) The wave of liquidation sent about $200 billion in cash flooding into bank and money market fund accounts. In the past 2 weeks some of that has already been redeployed.
Meanwhile the Treasury will still be putting out new paper which pulls cash out of the financial markets and sends it into the economic stream when the government spends it. The TBAC has forecast that the Treasury will issue $160 billion in new paper this month.
Only right now it’s not doing what it would normally be doing, and what the TBAC forecast it would do.
Here’s Why the Government Shutdown Is Bullish and What To Do About It
Because of the government shutdown, the Treasury hasn’t been issuing checks at its usual pace. In the first half of January when it was expected to issue $75 billion in new debt, it has issued ZERO! That’s $75 billion that gets to live in the financial markets for another couple of days, in fact as long as the government shutdown grinds on.. That will keep the stock and bond markets liquified, when they would otherwise have been starved for cash.
$15,000 richer in less than a month (and that’s just the beginning)
As usual, the reality is the exact opposite of the conventional wisdom. The government shutdown is bullish because the Treasury doesn’t need to borrow any money for the time being! That will be dramatically reversed when the Treasury needs to start sending those late checks out again.
But for now the reduction in payments allows the cash buildup that happened in December to continue to circulate in the markets. Trump has pulled out all the stops trying to get the market higher. He’s jawboned the Fed. He orchestrated the sideshow of having the Treasury Secretary announce that he called the big banks, and was activating the PPT. He announced that it was a great time to buy stocks. And he may well be using the government shutdown that reduces the need for Treasury borrowing as a means for keeping the stock market liquified.
Yesterday I recommended buying puts on the SPY as the SPX probed this resistance area between 2640. Given the conditions I’ve just cited, I would hold off on buying puts until the shutdown ends. That could be a perfect sell the news opportunity. If you have already bought puts, make sure to keep that mental stop at 2650 hard and fast.
Meanwhile, for options trading recommendations on both sides of the market …
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