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.
Here’s how it worked, why it doesn’t work anymore, and what we can to do about it to stay on top of the liquidity game.
Mark Twain famously wrote, “There are three kinds of lies: lies, damned lies, and statistics.”
Twain attributed the quote to British Prime Minister Benjamin Disraeli, but Disraeli never used it. Other British luminaries apparently did use it, but it was Twain who made it famous.
If it were up to me I’d phrase it, “There are three kinds of lies: lies, damned lies, and BLS statistics.” The BLS is that agency of the US Labor Department that brings us the monthly reports on the CPI and jobs, including non-farm payrolls and the unemployment rate.
In compiling those reports, the Bureau surveys tiny samples of business establishments and households. It then applies all kinds of statistical manipulation to project numbers that purport to show a snapshot of the entire US economy.
I have been actively tracking this data for 19 years. I must tell you that I have not been impressed with the quality of the BLS headline numbers that the Wall Street media dutifully spins to the public. With Twain in mind, forgive me if I refer to the BLS as the Bureau of Liar Statistics.
The BLS’s biggest and longest ongoing manipulation of the truth is probably the fact that they stopped including actual US housing prices in the CPI in 1982. That’s an issue I have brought to your attention several times in these pages. Since the beginning of the recovery in housing inflation in 2012 it has resulted in the CPI being understated by about 1% point on average.
While the CPI has this built in long running fudge factor, the jobs data is manipulated in so many ways my head spins at the thought of trying to figure it all out. The just released January payrolls data may have been one of the biggest whoppers a US government economic statistical agency has ever told.
And that matters. It matters because it influences monetary policymaking. So let’s take a look at what they misrepresented…