"Trump Trade" Or Just A $200 Billion Liquidity Illusion?

Tyler Durden's picture

Via Steven Vannelli of Gavekal Capital blog,

Since the election we’ve heard the rally in stocks characterized as a “Trump Trade” or a “reflation” trade. We think there is a really important element missing from this analysis that could change very quickly over the next several weeks.

On March 16, 2017 (the day after the Federal Reserve is expected to raise interest rates for the third time) the US Federal debt ceiling comes back into law at $20.1 trillion. At the end of January, total federal debt was $19.93 trillion, and in real-time using US Debt Clock (http://www.usdebtclock.org/) it is $19.93 trillion.

In anticipation of the debt ceiling coming back into force, since November, US Treasury deposits held at the Fed have dropped from over $400 billion to around $175 billion, unleashing over $200 billion of liquidity into the markets. In the chart below, one can see how US stocks leapt one week after the peak in US Treasury deposits at the FRB.

This has served to create the appearance that the Federal Reserve has been easing lately. Since 2014, the Fed has been slowly starting to reign in monetary accommodation. First it was by tapering, then in December 2015, the Fed began its current rate hiking cycle. Now, the Fed is still using the federal funds rate as the reference rate for monetary policy. This means that in order to lift the fed funds rate, the Fed needs to trim excess reserves in the banking system.

As can be seen in the chart below, the increase in commercial bank reserves is basically a mirror image of the US Treasury drawing down its balance with the Fed. The net effect of this is an unintended liquidity injection into the economy. To be clear, the increase in bank reserves is entirely a function of the US Treasury making preparations to hit the debt ceiling in the next couple months.

Taking a step back, it is important to understand the relationship between federal debt and interest rates. The suspension of the debt ceiling in the fall of 2015 led to an explosion in federal debt in 2016—helping to propel the economy (and likely in an effort to help the executive branch stay in Democrat control). This isn’t to say economic growth wasn’t for real in 2016, but it was heavily influenced by a surge in federal debt. If we move the year over year change in federal debt forward by three quarters, there is a very good relationship with the US 10 Year Treasury. The peak in debt growth several months ago could mark the near term peak in interest rates.

In the next chart, we show commercial bank deposits at the Fed overlaid on 10 Year US Treasury rates. The close relationship is hard to mistake.

Going a step further, the recent precipitous drop in US Treasury deposits at the Fed could telegraph a significant decline in interest rates this year. Why? Let’s say the debt ceiling is raised and the US Treasury wants to rebuild its account at the Fed similar to how it operated in 2011. The US Treasury will then issue a bunch of bonds, stick the proceeds at the Fed and basically remove several hundred billion in liquidity from the markets. This will manifest itself in lower commercial bank deposits at the Fed and a reduction in banking liquidity.

With the Fed set raise interest rates on March 15 and the debt ceiling set to kick in the next day, we think there is reason to question the recent appearance of abundant liquidity that has pushed up interest rates and supported stocks. Experience over the last few years is that each major reduction in commercial bank reserves leads to a lower interest rates and a stumble in stocks. We worry that we may be on the cusp of a difficult Ides of March.

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Belrev's picture

Did you see this?

Trump wiretap confirmed by former Clinton campaign manager Roby Mook


froze25's picture

Nice find dude!!!! That confirms what I said before, they tapped the other guy that just happened to be on the phone with Trump, so they in lawyer speak can deny that they Tapped Trump.

Logan 5's picture
Logan 5 (not verified) froze25 Mar 8, 2017 4:08 PM

Trump or no Trump.. It's ALL an illusion...




pay your price, get your tickets for the show

GUS100CORRINA's picture

I have always believed that things can be fixed if and only if those in authority with stewardship responsibility have "right, honest thinking". In other words, we have individuals in authority who are honorable in character, conversation and conduct.

But everytime I see charts like those presented in this article, I am really beginning to wonder if no one gives a CRAP because the END is NEAR and we just don't know it.

God Bless ZH for presenting TRUTH and for those on ZH who are willing to share TRUTH.


Chippewa Partners's picture

Mike Tyson in a PPV with Yellen and Kashkari.

GunnerySgtHartman's picture

The "Debt per Taxpayer" and "Debt per Citizen" numbers are interesting.  Using those numbers, the ratio of citizens to federal taxpayers is 0.3691 ... in other words, only 37% of US citizens pay net federal income taxes.  Clearly, not all US citizens are going to pay taxes (such as kids), but having 37% of taxpayers supporting the other 63% is just scary!

Honest Sam's picture

What are you some kind of anti-socialist, anti-communist, with feathers in your ears?   How are we ever gonna get to 30% paying all the taxes with protesters like you?

As it is, income taxes only pay for 25% of the expenses authorized by our deadbeat legislators. Where does the other 75% of our bills get paid from?  Corp Taxes only account for about 10% of our income.  

The rest??  From lenders.  Lenders are lending us over half of the money required to pay for the $700 toilets and hammers, the porn downloads at federal employees desktops, Barney Frank's anal condoms, and Jerrold Nadlers gargantuan gnosh in the all you can eat cafeterias. 

Half of the invoices from Lockheed are paid for by Chinese renminbi, Japanese Yen, Swiss yodelers, and Caracas drug dealers. 

Don't be afraid.  Be a survivor.  Adapt or perish.  Get someone to lend you 5 million or more and just vanish, off the grid. 

Salmo trutta's picture

Money creation is not self-regulatory.  It is self-reinforcing.  But you don't tighten monetary policy by raising the remuneration rate (or other policy rates).  If the FOMC pursues a rather restrictive monetary policy (hikes policy rates), market interest rates tend to rise in concert. 

However, raising the remuneration rate induces non-bank dis-intermediation (where the size of the NBFIs shrink, but the size of the DFIs remains unaffected).  It deals a death blow to the economy.  It dampens new money growth, but paradoxically drives existing savings out of circulation (thereby destroying money / savings velocity ->thus reducing R-gDp).  It exacerbates stop-go monetary mis-management.  I.e., it sucks non-inflationary savings out of NBFI circulation (non-bank financial intermediaries), and into stagnant (un-usable), commercial bank savings deposits (because the commercial banks always create new money whenever they lend/invest). 

And then it requires a larger dose of new, inflationary deposits, in an attempt to counteract its recessionary, mis-allocated, and mal-distributed, economic impact (i.e., one where there’s not a matching and offsetting addition to the supply of new goods and services). 

Thus, it decreases overall incomes and perpetuates secular strangulation.  With a knew-jerk reaction, the economy begins to suffer.  Unfortunately, rates are being driven again, by FOMC schizophrenia, do I stop? or do I go?

E.g., 3rd qtr. 2008 when inflation accelerates relative to real-output - in the latter stages of any business expansion whenever the Fed tightens monetary policy.  And then Bankrupt u Bernanke tightened just as the economy nosedived.



In.Sip.ient's picture

So the entire DJIA over 20K deal

is the FED dumping treasuries to

play the stock exchange?


And now what???


Herdee's picture

If they don't hike, a lot of people will get shafted pretty bad, especially if there's no lifting of the debt ceiling. It actually means that the President can take direct control of spending and how money gets spent if there's no agreement. He has a lot of power that has been given to him over the years.

yogibear's picture

Now that there is complacency with the Muppets it's time for fear. 

Doug Eberhardt's picture

We haven't even come close to the deflationary credit contraction collapse yet. The Fed still only looks at U-3 unemployment, ignores U-6 and thinks a bump up in oil price we have had is inflation. They completely ignore declining GDP. Go ahead and raise rates Yellen. Gold will speak the truth here shortly. Then you get fired as Trump will do what he can to get the dollar to fall.