Earlier this week I showed you an indicator that shows the level of trading accounts in the US commercial banks. It has a strong direct correlation with the direction of Treasuries. This indicator is now in position to confirm the breakout above 2.5% in the 10 year yield. That’s an event of potentially biblical proportions in its implications for US and world markets.
I promised that we would take a look at the relationship between that indicator and stock prices. I did, and it’s not worth reporting or illustrating. The correlation, if any, is too weak to be useful to us in estimating the direction of securities prices.
The world’s central banks have tilted the playing field to the extent that the markets are grossly distorted. The Fed and its cohorts have created a monetary tsunami that has given the US stock market what appears to be a permanent trend bias to the upside. But we also know that this won’t work forever. Sooner or later the Fed and its cohorts at the European Central Bank (ECB) and Bank of Japan (BoJ), must relent. The tsunami will recede and leave a swath of unimaginable destruction.
The markets will leave the central banks no choice but to pull back as their policies will continue to fail to stimulate economic growth, and continue to stimulate rolling market bubbles, particularly in the US. At the same time, a set of conditions could easily develop where the markets simply self immolate.
The conditions are ripe for that as markets, particularly US stocks and bonds, bubble out of control. Social stresses only grow as the one percent is continually enriched while the bottom 90% steadily loses out.
They lose out because economies simply can’t and won’t add high quality, good paying jobs, that most workers could perform. Smart machines are constantly replacing those workers.
This is a systemic secular trend that monetary policy could never, and will never fix. Central bankers have only exacerbated the problem with their money printing policies. There are glimmers that their exercise in futility is beginning to sink into their narrow, twisted, delusional minds.
One domino has already fallen. That’s the Fed. It stopped outright money printing two years ago, and at least didn’t sink into the raving madness of negative interest rates as its partners in crime have.
But the Fed is still using trickery to force feed at least a small stream of cash into the banks. Under the absurd and unchallenged pretense that it is raising interest rates, it is actually increasing its cash subsidy to the banks. It does so by paying an increase on the interest rate o the funds that the banks hold at the Fed. This rate is known as Interest on Excess Reserves or IOER.
The Fed has increased IOER by 50 basis points over the past year, including this week’s 25 point increase. On average it will now pay the banks around 62.5 basis points. The Fed pays that interest on roughly $2.5 trillion in reserves. If we do the math, it amounts to around $15.5 billion a year that the Fed is handing over to the banks for nothing! For no reason! The banks haven’t earned it. It’s a gift!
Obviously, $1.25 billion per month in payments to the banks won’t have an effect on the market. It’s barely a rounding error compared to the hundred billion or so per month that the Fed pumped into Primary Dealer trading accounts during QE, which ended in 2014. But it’s still two bit scam to give the banks a backdoor subsidy. It’s morally outrageous and financially indefensible in that it only serves to fatten an already fatted pig.
Each 50 basis point increase in IOER reduces the amount of the Fed’s surplus by $1.25 billion per month. The Fed returns that surplus to the US Treasury. The reduction of the Fed surplus is a direct cost to taxpayers.
For example, in October 2015, before the first increase in IOER, the Fed returned $7.5 billion in surplus (aka profit in the private sector), to taxpayers. In October of this year that amount was $1.2 billion less, at $6.3 billion. In September the total was $3.5 billion less.
The number varies from month to month. The Fed often increases its welfare program for unemployed and unemployable economists, as it provides them with do-nothing research jobs, again, at taxpayer expense.
That jobs program for economists will gradually have to be cut back. Because with each increase in the bank IOER subsidy of 50 basis points, the Fed surplus returned to the Treasury will shrink. It would only take 8 quarter point increases in IOER to bring that surplus down to near zero. Such an event would ignite a political firestorm.
So it’s likely that they won’t push IOER much above 2%. The Fed wants to keep a lid on the hubbub from the Trump gaggle of useless economists nipping at the Fed’s heels.
Here’s why this information is important to us as investors. While the Fed isn’t actually raising interest rates, it is giving the impression of doing so. Simply giving the impression of tightening may have no economic or financial impact on the US. But it is certainly detrimental to the rest of the world as the dollar strengthens in response. The resulting dollar short squeeze is causing a vicious spiral of destruction in weaker financial systems around the world, especially in Europe.
Banks there and elsewhere have trillions in dollar denominated debt. As their own currencies weaken against the dollar, they are unable to service the ever increasing cost of that debt in dollars. This forces them to sell Treasuries to pay off the debt. Treasury yields rise. T-bill rates follow along.
As the foreign banks sell Treasuries dollar deposits are extinguished as they’re used to pay off the debts. The shortage of dollars only increases making their situation ever more dire. They need to sell another round of Treasuries, and the spiral worsens.
That continually feeds back into the US market in the form of higher short term rates and bond yields.
The rise in US rates is not caused by the fact that the Fed is now paying the banks a bigger subsidy. It is caused by the Fed’s PRETENSE of raising rates. Investors and traders act on that belief. That action is now showing signs of increasing its momentum. An uncontrollable implosion may lie ahead.
The past 5 months have not been a good time to be holding fixed income securities, and that isn’t likely to change anytime soon. As the margin calls go out around the world, the need to liquidate whatever can be liquidated forces banks and other holders of rapidly depreciating securities to sell whatever isn’t nailed down to raise cash. This means that the end is drawing near for the manic bubble in stocks.
For years, the mantra among big money traders has been to buy the F’n dip! The conditions that we see developing today point to that soon becoming, “Sell the F’n rip!”
In the days ahead I’ll show you a chart of another indicator of US banks security holdings that is on the verge of a critical signal for stocks.
This report is derived from Lee Adler’s Wall Street Examiner Pro Trader Monthly Reports on the US and European banking systems.
Lee first reported in 2002 that Fed actions were driving US stock prices. He has tracked and reported on that relationship for his subscribers ever since. Try Lee’s groundbreaking reports on the Fed and the monetary forces that drive market trends for 3 months risk free, with a full money back guarantee. Be in the know. Subscribe now, risk free!