Lee Adler discusses his Composite Liquidity Indictor – a composite indicator that examines a variety of influences on market liquidity. A high composite indicator is bullish. Currently, the indicator is high, the two most influential components are high as well.
Courtesy of Lee Adler of the Wall Street Examiner
The composite liquidity indicator surged upward last week, driven by the huge Fed settlement of its monthly forward MBS (mortgage backed security) purchases. [That is, money is flowing from the Fed to the Primary Dealers, in exchange for the MBS the Primary Dealers are selling to the Fed.] This always takes place in the 8 day period surrounding mid month.
Most components [of the composite liquidity indicator] had sympathetic upmoves on a smaller scale. The factors that slowed the rise in the indicator over the prior 3 weeks have receded as expected. The trend to the upside should continue at a breakneck pace as each new round of Fed cash hits the market and flows into the banking system.
Two large Cash Management Bills (CMBs) issued by the Treasury last week and this week will offset the effects of the surge of Fed liquidity in the short run. (Money will flow into the CMBs being sold by the Treasury.) CMBs of $75 billion plus note, bond, and bill settlements of $43 billion of net new paper will absorb all of the Fed’s cash injections over this period. Obviously there are other buyers for this paper as well, but the CMBs and increased offerings of 4, 13, and 26 weeks will blunt the bullish effects of the Fed’s printing this month.
Without the Fed providing the cash to absorb all this new supply, the effects would be much more bearish. Likewise, were it not for the Fed, the effects of the repayments of the ECB’s LTRO (Long-Term Refinancing Operation) program loans would have been more bearish. There was a large LTRO repayment in early February that reduced worldwide liquidity. Another similar paydown is coming in March.
As the February repayment did, the March LTRO repayment will draw down bank deposits worldwide and put another minor crimp in US market liquidity similar to the one over the previous few weeks. That should be temporary. A bump in the market road is likely, particularly for Treasuries, in the wake of this paydown, but as long as the Fed keeps pumping, the tide of systemic liquidity should continue to rise exponentially in the US and stocks should continue to oscillate along that upward wave.
The best chance of a market hiccup will come late this month and in early March, the period between Fed MBS settlements, which will coincide with the new big round of ECB LTRO repayments.
Macroliquidity Component Indicators
Fed Cash to Primary Dealers measures the flow of cash into Primary Dealer accounts from Fed securities purchases. This indicator has the heaviest weighting in the composite. The current growth under QE3/4 is the fastest in history. It will be bullish until the Fed ends QE.
The correlations have held remarkably well since I began tracking this in 2002. It is a proprietary indicator composed of the cumulative value of operations which the Fed conducts directly with Primary Dealers.
Foreign central bank holdings of Treasuries and Agencies are a very significant factor in market liquidity. This is the second most heavily weighted indicator in the composite. This indicator has turned bullish following an all time record increase in the week of February 6.
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