Treasury

Are You Aware of This “Liquidity Shock”?

By David Stockman  |  August 7, 2019

What’s gone up like this market has, on fuel of little lasting substance, will surely come down with enough weight to squash the stupidity that floated it.

Well, actually, the Federal Reserve is doing everything it can to create more of the same…

It’s nearly tripping over itself in the process. I mean that literally. Sometimes you must be explicit about these things; that’s because these are subtle steps our monetary central planners take in their attempts to engineer their preferred outcomes.

Though it’s just some of the background noise amid the Donald’s escalating Trade War/Currency War that’s sure to dominate Bubblevision’s attention, consider, for example, the following…

The Fed is on track to do its final $70 billion of quantitative tightening (QT) in August and September. That’ll suck $70 billion of liquidity from the bond market each month.

It’s likely to be matched by another $300 billion cash drain orchestrated by the Donald’s own Treasury Department.

Steve Mnuchin gets great use of his well-worn kneepads. He’ll need a new set for this one, the ironic downside of the abominable budget-and-debt-ceiling deal the Duopoly hashed out in Imperial Washington two weeks ago.

The Donald’s about to get whacked good and hard by a final blast of QT, this time one with no dilutive offsets.

That budget deal means we will avoid another shutdown crisis. We’ll also steer clear of the “default” bogeyman.

But as Ambrose Evans-Pritchard recently noted, since March 2019 the U.S. Treasury has been conducting a form of stealth fiscal “quantitative easing” by running down its cash balances in the absence of borrowing authority.

It’s accomplished by draining the U.S. Treasury’s GTA account at the Fed. And it means injecting cash into the market to pay government salaries, contractors, interest, etc.:

This has been a net injection of money into the US economy. It is akin to QE and has overwhelmed the effects of quantitative tightening (bond sales) by the Fed pulling in the opposite direction. Or put another way, it has masked the underlying withdrawal of dollar liquidity.

The debt ceiling agreement will result in a surge of Treasury borrowing to replenish its cash account to about $350 billion. That’s its standing target of slightly under one month’s worth of outlays. And, given the calendar timing, it might need another $150 billion to cover a seasonal operating deficit for August.

As Evans-Pritchard further noted,

A higher debt ceiling has potent implications for Wall Street and dollar liquidity. It could cause a financial squeeze and tremors across the credit system.

Once there is a deal the Treasury will rush to rebuild its cash buffers by issuing a blizzard of bills. This sucks money back out of the economy. Think of it as reverse QE.

Such effects would be transmitted instantly through the global financial system via the vast off-shore dollar lending markets. So be alert.

According to James Ferguson at MacroStrategy, these periodic debt-ceiling-increase-based liquidity shocks to the bond market tend to roil the entire financial system.

That includes the stock market: “Based on the last three times it has done so, roughly each $100 billion or so that the Treasury deposits in the bank, the S&P 500 loses about 100 points (and vice versa). Liquidity matters.”

The implicit fiscal QE tailwind since the beginning of the year has put a net $200 billion of cash into Wall Street dealer accounts. It’s reversing, big time.

Indeed, save for the April tax season bulge, the moment of reckoning would’ve been forced already.

Whether he’s reacting to this particular liquidity shock will certainly be open for debate.

The Donald does not remotely see this happening. You can be sure, though, that the Tweeter-in-Chief will spare no purple prose blaming the Fed for the result of his own Fiscal Debauch.

Wall Street may have some inkling. But it’s most concerned with China, the Trade War, and the Currency War right now; suffice to say it did greet the budget deal by going giddily green the day after it was made.

But this otherwise substantial shock is, alas, now reduced to just another part of a perfect August storm.

“Now” Is a Good Time to Tune In…

Desperate times call for… “common sense” measures.

And these are desperate times… Markets are corrupted by monetary central planning. They’re confused. And the road back is going to be treacherous.

We’re looking at a major re-pricing for all financial assets. And thousand-point intraday or day-to-day swings are part of that equation. Those can be frightening… for “buy and hold” investors.

I have a different approach, one that combines strategy and tactics into a plan flexible enough for you to survive and thrive amid the coming chaos. It’s called “The Stockman Model.”

All we’re after is a little stability, perhaps a chance to pocket a windfall when opportunity presents…

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR