Were you watching CNBC yesterday? If you were you know all about the Fed meeting minutes. They were all over the online financial media too. The universal take was that the Fed has turned dovish, and that it will pause raising rates. And everyone agreed that that’s bullish!
But is it?
Previously, Chairman Powell had held firm to the idea that the Fed would only loosen policy if the economy materially weakened. He had said that the Fed wasn’t concerned about possible stock market declines, but would be motivated to ease policy only if the economy contracted as a result, particularly if housing was the cause.
But the stock market selloff in the fourth quarter combined with relentless pressure from the White House spooked him and his cohorts on the FOMC. Apparently Chairman Powell is no Paul Volcker and no Chairman Pow! Faced with a challenge from the market, he turned into Mr. Softee. Wall Street concluded that, yes Virginia, there really is a Powell put.
The Wall Street Journal led the story with the headline and subhead, Fed Is Unlikely to Raise Rates in Next Months, Minutes Show – Recent market volatility and signs of slowing global growth made ‘extent and timing of further policy firming less clear’
Reporter Nick Timaraos explained, “Federal Reserve officials signaled they are unlikely to raise interest rates for at least a few months while they assess the impact of recent market volatility on the U.S. economy.” He went on to say that stocks sold off because “Powell presented a confident outlook in a postmeeting press conference that conveyed to some investors a greater bias toward rate increases than they anticipated.”
And here I thought that the markets were weak because they were starved for liquidity! Indeed they were.
The Real Reason Why The Market Sold Off is Not What The Wall Street Journal Said It Was
In fact, the markets were starved for liquidity throughout the fourth quarter. The price action speaks to that.
The Journal this morning said that we now know why the market sold off. It was supposedly because companies are now cutting first quarter sales forecasts. But that’s bull. The stock market selloff is WHY they’re cutting their forecasts, not the other way around.
Business decision makers take their cues from stock prices. A big selloff makes everyone cautious. So they reduce their expectations, and maybe cut spending a little. We’ve seen this time and again in both consumer and investor surveys. Everybody follows the market. Nobody gave any thought to the economy possibly weakening until well into the market plunge!
But meanwhile, all that liquidation in December sent a mountain of cash into money market funds and bank accounts. And that sudden rise in temporary liquidity is what turned the tide.
Selling equals liquidation of course. It destroys capital in the process as prices and account values fall. That in turn destroys margin. Margin calls go out, stocks get liquidated, margin loans get paid off and cash disappears from the system. That’s how orderly selling can and does destroy money. “Liquidity” is just a fancy word for money, after all. And until December, the selling was orderly and measured. There was no panic. Complacency reigned.
Orderly Selling Destroys Liquidity But Panic Selling Spins Off A Cash Build
But there’s a difference between orderly selling and panic selling. December saw real panic, and in selling panics, more sellers are raising cash than are simply paying off margin loans. The cash from that selling flooded into bank accounts and money market funds in December. Institutional and retail money market funds saw $100 billion in combined net inflows. Total deposits, both checking and savings, in commercial banks also rose by $105 billion.
That means that total money liquidity in the US system rose by $205 billion during the month. That was a lot more than Treasury issuance in December. So suddenly there was lots of fuel sloshing around just waiting for a match to be lit.
The juxtaposition of the selling in stocks (red line) with the increase in cash in bank and money market fund accounts is striking. Cash soared as the selling picked up.
That total deposits line includes the impact of the Fed draining $50 billion from the system. The selling in December generated a truly awesome pile of cash. It was 5 times the size of the Fed’s draining operations, leaving a net increase in cash of 4 times the amount the Fed drained.
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Unwanted Money Causes Professional Investor To Develop An Itchy Rash
By Christmas, that cash was burning a hole in investors’ pockets. Professional investors get itchy when they are sitting on a load of cash. It makes them nervous not to be fully invested. They start to sweat, and twitch. They just have to scratch that cash rash. A well timed intervention from the Trump Regime was all it took to trigger a cash rash, scratching orgy, buying panic.
There’s no question that a little cash built up on the sidelines a few keywords for the stockbots from the Treasury Secretary and the President can trigger a panic that feeds on itself for couple of weeks.
But such buying panics will not change the direction of the major trend. Throwing rocks in a river will make a splash, and big rocks will make a big splash, but they will not change the direction of the flow. $200 billion in cash plus the Treasury Secretary telling the market that the PPT would be on the job was a cannonball.
I doubt that the PPT (Plunge Protection Team) was really called in like Mnuchin said it was, but it doesn’t matter. It only matters that the professionals at the institutional trading desks could not just sit on their hands, given that news. Look, Mnuchin was in the business at the highest level. You may not like him. He may be a cretin. But he’s no fool. He knows how the game works, and he played it well.
But You Stay Calm and Rational Because You See This For What It Is
Now I still think that rallies need to be sold. We can buy near in the money puts on the SPY with about 4 weeks remaining till expiration when the S&P 500 is near resistance, like it is now. When entering a trade like that, always have a protective mental stop in mind just the resistance level on the S&P. In this case, I’d use 2650 as my failsafe. Likewise, I’d look to take profits when the market approached the recent lows, or leave the trade if the market didn’t start to sell off within a couple of weeks. Time is not our ally with options purchases.
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