Courtesy of Lee Adler of the Wall Street Examiner, highlights from Lee’s Fed To Market: Can You Say ‘Ho, Ho, Ho?’ Professional Editon.
Ilene’s comments in blue italics.
The composite liquidity indicator rose last week mostly due to the Fed’s first MBS purchase settlements under QE3.
The Fed bought Mortgage Backed Securities (MBS) according to the new quantitative easing (QE3, aka QE-Infinity) program announced in September 2012. The money went into the Primary Dealers’ trading accounts. Lee’s proprietary liquidity indicator (below) has been drifting higher.
Note: Primary dealers (PDs) serve as the New York Fed’s trading counterparties in implementing the Fed’s monetary policy. In more ordinary terms, the Primary Dealers are the big investment banks such as Goldman Sachs, JP Morgan, Barclays Capital, Citigroup Global Markets, Credit Suisse Securities, Deutsche Bank, HSBC Securities (USA), Jefferies & Company, Morgan Stanley, Nomura Securities, UBS Securities and others (list).
Composite Liquidity Indicator
The uptrend in market liquidity is still firmly in place. The composite liquidity indicator will make new highs each month ahead as the Fed continues to settle its QE3 MBS purchases, pumping cash into Primary Dealer trading accounts.
When the Primary Dealers are flush with cash, stocks benefit–the Primary Dealers buy not only Treasuries, but also stocks and commodities.
As QE3 cash hits the system, it should have both a direct impact and also flow through several of the other components of this index. Any deviation from that expectation could be a sign of fundamental problems, with fictitious capital vaporization always lurking just behind the “all is well” façade.
The Fed’s purchases from Primary Dealers carry the heaviest weighting in the index (the composite liquidity indicator). Foreign central bank (FCB) purchases are the second most important weight. It has turned modestly bearish (see The Flow of Money for more on the FCBs).
Fed Cash To Primary Dealers
A fair question would be if the Fed Cash to PD indicator is so bullish, why have stocks been weak lately? The answer is probably partly because of the $70 billion in Cash Management Bills that the Treasury has sold in the past 3 weeks. That has been like a cash call on the Primary Dealers, hampering their ability to deploy cash to drive stocks and commodities higher. However, it hasn’t hurt the Treasury market which continued to attract foreign flight capital and domestic public demand.
It is unlikely that the Treasury will continue to vacuum up all available cash with cash management bills in the months ahead, and the next big round of QE3 cash will hit the market in mid December. Can you say, “Ho, Ho, Ho?”
Summary: The Fed continues to pump cash into Primary Dealer trading accounts via its MBS purchases. The Fed Cash to Primary Dealers Indicator has the heaviest weighting in the Composite Liquidity Index (top chart). With the Fed about to buy even more paper from the PDs for an indefinite period, this input will remain bullish until the Fed changes course. Because the Fed Cash to PD component is so strongly weighted, the Liquidity Composite is likely to remain positive.
Read the full newsletter: Market Shadows Newsletter (11/25): From Fed, With Love.
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