17 years ago I developed an indicator to track the amount of cash that the Fed was pumping into Primary Dealer Trading accounts. The indicator proved its mettle over time. It was one of the best predictors of stock market behavior because Primary Dealers literally “make” the markets. Market price levels reflect how much cash the dealers have on hand to ignite the cycle of securities inventory markups and markdowns that drive market price trends.
The indicator is composed of the cumulative value of operations which the Fed conducted directly with Primary Dealers in Open Market Operations (OMO). It measures the flow of cash into Primary Dealer accounts that came from the Fed’s purchases of securities from them. It’s similar to some of the charts you see of how the market tracks the Fed’s balance sheet. But there are some important distinctions that made it work better for us.
There’s just one problem.
Those distinctions no longer matter.
The Fed isn’t buying securities from Primary Dealers any more. It’s no longer pumping cash into the markets. It stopped doing that in October 2017, when it started the systemic bloodletting program known as “normalization” that has caused so much consternation in the market.
And it isn’t selling securities to the dealers under that program either. That would be one way to shrink its balance sheet and pull money out of the banking system. The Fed has opted for another way. That is to simply redeem its holdings of US Treasury notes and bonds as they mature. The Fed also allows its mortgage backed securities (MBS) to be paid off by normal prepayments over time.
It’s a passive approach, but insidious and dangerous.