As the market stages a spirited rally off a test of the lows and the 200-day moving average, it's important to keep one thing in mind. Liquidity factors are not going in the right direction and won't be for a long time. Consequently, I see every rally as a gift, an opportunity to sell before the real ugliness gets underway later this year.
The most important driver of liquidity, after the Federal Reserve, is the U.S. Treasury, and it is not a positive. It is sucking hundreds of billions of dollars out of the worldwide liquidity pool that fuels financial asset purchases.
Four factors have exacerbated that problem. They all require the Treasury to borrow more money, issuing more and more debt for investors to absorb without the help of the Fed replenishing the cash pool as it did every month under QE. In effect, the Treasury is crowding out the stock market.
Here's what's happening to all that money – and what you can do to profit as it disappears…
Four Factors Forcing the Treasury to Drain Money – and What That Means
The first factor is that the Fed is adding to the problem. Instead of buying Treasuries and mortgage-backed securities from Primary Dealers to fund the new Treasury issuance each month, the Fed is now pulling money out of the markets via its balance sheet shrinkage program. In addition, the Fed is forcing the Treasury to sell additional debt to raise the cash to pay off the holdings that the Fed is now redeeming each month.
The second factor is that the Trump Regime and rubber-stamp Republican Congress made a budget deal that will massively increase the deficit. The Treasury must issue more debt to cover the shortfall.
The third factor is that the Trump Regime is following the Treasury Borrowing Advisory Committee recommendation to raise a $500 billion cash kitty for "contingencies," after draining $440 billion, virtually the entire existing fund, during the first couple of months of its new administration. Now they're trying to rebuild that kitty, and they're about halfway there. So they still need to suck another $250 billion out of the markets in the months ahead. That's carrying coals to Newcastle.
The fourth factor is the tax cuts. The Congressional Joint Committee on Taxation estimated that the tax cut would cost the federal government $270 billion in lost revenue in the first year. We now know from the February and March data on federal tax collections that that estimate was right on the money.
At the same time, we have real-time data showing that the U.S. economy is booming but revenue is falling, exactly the opposite of what the idiot supply-siders claim should happen. But that's beside the point. The point is that revenue has fallen and it can't get up. There's no supply-side Life Alert coming to the rescue.
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Withholding tax collections continued their decline in the month ended March 30, as employers adjusted their withholding to the new tax law.
Year-to-year comparisons for purposes of estimating the strength of the U.S. economy will be questionable until February 2019, a year after the tax cut impacts began. But the data does show us how much the tax cut is costing the U.S. Treasury. That's money that it needs to raise in the market by selling debt. And that is critical information.
The loss of tax revenue due to the tax cut is running $20 billion to $25 billion per month. The Treasury will need to sell that much additional debt, plus what it needs to redeem the Fed's holdings, plus the shortfall from the increase in the deficit arising out of the federal budget deal passed early in February, plus what it needs to add to its "rainy-day fund" kitty.
We expected these factors to cause some of the largest monthly debt sales in U.S. history, and they have. Net new issuance was a mind boggling $270 billion in March.
There's a short-term cycle in tax collections every three to four months. That was due to turn up in March. Instead of turning up, it remained flat, in negative growth territory. With no sign of an upturn in revenues, the Treasury will continue to pound the market with enormous supply.
There's a respite from that every year in April as yearly 1040 taxes come in, but that respite will be far smaller than usual this year thanks to the increase in the government deficit.
At the same time, excise tax collections are booming, suggesting a booming economy in some sectors. That will show up in the economic data for March. The Fed will stay focused on that and will stay on a tightening path. That's bearish.
A Deeper Dive into This Month's Tax Data Shows a Steady Bearish Trend
Withholding tax collections continued their decline in the month ended March 30, as employers adjusted their withholding to the new tax law. The new tax cuts took effect in January, but the IRS did not publish new withholding tables until mid-February.
While we cannot accurately adjust for the impact of the tax change in year-to-year comparisons, I think it's notable that we are not yet seeing the usual cyclical upturn that typically occurs every three months or so. The tax cuts apparently are not acting as stimulus like they are supposed to.
Withholding tax revenue fell by $5.5 billion year to year. That followed a $3.1 billion decline in February. These numbers may not sound like much, but compare them with January, which was before employers adjusted their withholding. January had a year-to-year increase of $19.5 billion. Relative to that, March plunged $25 billion.
The average gain for November through January, before the tax cut, was $15.3 billion. This month therefore represents a loss of roughly $21 billion per month in withholding taxes compared with the average of the last three months before the tax cut took effect.
Those two comparisons suggest that the monthly revenue loss is in the $20 billion to $25 billion range.
Total taxes were only down $1.5 billion in March, but they were up $24.9 billion in January, so there was a significant downswing there as well. This was despite gains in excise taxes and individual income taxes. I'd take the individual income tax figure with a grain of salt. Quarterly estimated taxes are due in January. March payments are only from procrastinators like me who are late paying, or early April 15 birds.
March corporate tax payments represent the taxes for 2017. The payments are the difference between what corporations paid in estimated taxes throughout the year and the final amount due. The big drop suggests that business profits were not as good as reported on their financial statements. The drop looks ugly, but I would not give that much weight. No doubt some big businesses played bookkeeping games to push profits into 2018, when the corporate income tax rate is much lower.
Excise taxes rose a strong 7.8% after a solid 5.2% reading in February. These numbers suggest an overheating economy.
While there's possible evidence of slowing in employment, the excise tax data suggests that the top-line economic numbers will show strong growth. The Fed will stay on its schedule of shrinking the balance sheet. The Treasury will continue to pull enormous sums of cash out of the markets. Money rates will rise as short-term and long-term government debt suck up every penny of a shrinking pool of cash. Bond prices will fall and yields will rise, taking turns with falling stock prices.
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.