If you're interested in secret societies and world domination, you're reading the right article.
Sort of.
"No one puts Baby in the corner," but someone tells the Treasury what to do.
To be precise, it's a small, powerful group comprised of some of the most powerful players among primary dealers and international banking. It is tasked with recommending to the Treasury how much new paper it will need to issue in the months ahead to cover its deficit and maintain a cash cushion. You don't hear much about this group - but they're the "power behind the throne."
Right now, they've just issued guidance for a nefarious $463 billion release - early next year - that could cut the stock market off at the knees.
Here's who they are - what they're planning - and how you can protect yourself.
I'll get straight to the good stuff. The Treasury usually sticks closely to the recommended issuance of the TBAC (Treasury Borrowing Advisory Committee). The TBAC has recommended that the Treasury rebuild a contingency fund of $500 billion. November's issuance was a step in that direction. But there's more coming.
The TBAC just issued guidance for Q1 2018. It estimates net new supply of an astounding $512 billion for the quarter. That includes just $49 billion in January. That means that $463 billion in net new supply will be issued in February and March, including $205 billion in February and $258 billion in March.
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I don't see how the markets could absorb this much paper without buckling. I would expect there to be some liquidation in both bonds and stocks. Consider that the Fed will be simultaneously be pulling $20 billion per month out of the banking system and that the ECB will cut its QE purchases in half, and I see dead people on Wall Street.
The forecast for December is for $164 billion in net new supply. I would still expect that much supply to pressure the market.
If it doesn't, I would guess that the payback that comes, probably in January, will be painful. I was wrong about that for November, and maybe will be wrong again in December, but this is a case of robbing January and February to pay November.
Here's Why the Treasury Flood Is Set to "Extinguish Money" Early Next Year
The long-term trend of Treasury auction supply is now showing the earmarks of trend reversal. Supply for mid-December has been scheduled and it is higher than a year ago. Chartists will recognize that the 12-month moving average has broken out of a reverse head-and-shoulders pattern. That's a classic reversal sign. The 12-month MA has made a higher high after a higher low after a long period of basing.
Meanwhile, demand as represented by the total amount bid per auction remains in a downtrend. The total bid tendered in November was virtually unchanged from November 2016 despite the increase in supply.
But yields didn't rise. Again, I blame an unusual increase in speculative leverage. This chart depicts the type of short-term loans that dealers and speculators use to finance securities purchases...
[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
Increases in this type of borrowing are always associated with bond market moves. But not this time, particularly since the middle of the third quarter. Bonds haven't moved. But stocks have. It suggests that the rally in the stock market has been at least partly driven by an increase in speculative leverage.
That leverage will likely be unwound beginning in the first quarter of 2018 as the Fed's draining operations begin to take a toll.
Those operations will require the Treasury to increase debt offerings to raise the cash to pay the Fed for the holdings that it is redeeming. Dealers and investors will buy that paper partly with cash that they'll withdraw from their checking accounts. It will go to the Treasury, and the Treasury will in turn pay off the paper held by the Fed.
That's how deposits will come out of the system and money will be extinguished as the Fed's balance sheet shrinks. Less money translates into less demand for securities in an ongoing process that will increase in severity as the Fed drains more and more from the system.
Keep raising cash by selling into the rally periodically with the goal of raising a 60% to 70% cash cushion by the end of January. It could be more, or a little less, depending on your personal circumstances. If you haven't started yet, do so with the goal of reaching that benchmark by the end of the first quarter. By then, I believe that cash will be king.
Our LAMPP Forecast Remains Virtually Unchanged...
The long-term LAMPP remains a hair above a red signal. The Treasury continues to issue large amounts of new debt, and the Fed has begun to settle fewer MBS purchases and to require the payoff of a small amount of Treasuries from its balance sheet. In January that amount will increase to a total of $20 billion, up from $10 billion. This will drain cash from the banking system.
If the Treasury continues to issue new debt at the rate the TBAC has forecast, then the long-term LAMPP should flash a red signal in roughly four to five weeks. That's the first week in January. It wouldn't be the first time the market has peaked in January.
However, the reimposition of the debt ceiling is a wild card. The Treasury may continue to issue debt by using accounting gimmicks as it did in the past go round of this exercise. Or it may suspend issuance until a budget deal is passed. That would keep a lid on supply and delay the red signal.
The short-term LAMPP remains red. This signal has appeared to be wrong, although for several weeks my short side trading picks in the Wall Street Examiner Pro Trader model trading portfolio were doing better than the longs. Over the past three weeks, longs are outperforming and shorts are underperforming.
The stock market is running on fumes, apparently driven by foreign inflows and increased use of margin and other types of leverage by traders. No doubt short covering has played a role in the rally as well. When this is exhausted, it's likely to end with a thud.
In the meantime, I would not be buying long-term positions. In addition, while it has worked for the past couple of weeks, even short-term trading from the long side will become increasingly risky over the next three weeks or so. When the long-term LAMPP turns red, I would concentrate on trading from the short side.
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About the Author
Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.