Treasury Supply

"Unless the FCBs step up to the plate much more than they have in the past couple of weeks, either the Treasury market will collapse, or the stock market rally will fizzle, or both. We’re not there yet." Lee Adler

The market has begun to choke on the additional Treasury supply dumped on it by the foreign central banks (FCBs).

Do I have a lot of confidence in this outlook? Uh… no. 

So, in case I didn't make myself clear, I guess I'm kind of bearish. DOH!!

Perceptions have turned very negative and the media has been increasingly playing on fears (e.g. the U.S. debt ceiling crisis and the big default scare). If the economy gets so bad, and the stock market falls low enough, many believe the Fed will step in with another short term fix to prop up the stock market - QE3.

From the televised speeches of Obama and Boehner, to the hard-line tactics of the Tea Party, to the pitiful cobbled-together agreement the House put together late Friday - there has been no shortage of grandstanding, posturing or spouting of rhetoric.

Where is the money coming from to buy stocks? 

The Fed will never be able to reduce the size of its balance sheet. In fact, it will need to begin expanding it soon.

Next week’s calendar is light, with another paydown on Thursday and plenty of POMO, so if ever stocks had an excuse to rally, this would be it.

Not only are the PDs treating Treasury paper like last week’s garbage, banks in general are also dumping the stuff.

"The market now sits right on a major trendline. If it is decisively broken, a bigger decline could lie ahead after the end of POMO."

Recently there has been lots of goalseeked speculation by sellside research about what the impact of QE2 will be. Considering that the biggest force in bond buying (PIMCO) disagreed with virtually everyone else, it is safe to say that nobody has any idea what will happen on July 1 (of course unless the Fed also actually stop its off-balance sheet curve vol selling, in which case the imminent collapse in the bond market is guaranteed). Naturally, after the private sector has come out defending its respective books, here come the Admirals of the Obvious from the San Fran Fed to voice in on just how good and wise QE2 was especially when compared to such a "monster" as 1961's $8.8 billion Operation Twist. According to the Fed, Operation Twist, which was truly a curve "twisting" operation instead of an outright debt monetization and deficit funding operation, succeeded in reducing rates by 0.15%. It is this delusion that fostered QE2, which is merely a continuation of QE1 and a contributor to the Fed's soon to be $2.9 trillion balance sheet, as the Fed was obviously trying to recreate history. Little did it realize that Twist was not about the implosion of a shadow banking bubble but all about removing rate arbitrage opportunities. Curiously enough, it was the rush of gold from the US To Europe, to express this arbitrage, that forced the US to engage in Operation Twist. Only later was the gold backing of the dollar completely removed thereby eliminating this arb opportunity. Of course, it is now deja vu all over again: the Fed has to do all it can to prevent the transfer of fiat into gold, albeit at non-fixed rates, or as some have called it, a non-central bank instituted gold standard. Yet oddly enough, despite all time record nominal prices, the demand for gold is only increasing, a result that the Fed had not anticipated at all and is forced to scramble to reverse. And now that QE2 has been a complete failure, the only option is to back track on everything and admit the Fed has failed, or pursue more QE, sending gold offerless. Your call Ben.

About 50% of what’s going in from the Fed now is rollover money... (The Fed) is buying 85% of the Treasury notes. They can’t stop. How could they stop? Who’s going to buy?

If the Fed desists or scales down its Treasury buying, the stark trillion dollar question becomes who will buy them?”