Raising The Debt Ceiling – Is The M-FAT Indicator Wrong?
Contrary to conventional wisdom, raising the debt ceiling is normally bearish. When the debt ceiling is in force, it’s bullish.
That’s not opinion. It’s an observation. And with good reason.
Liquidity moves markets!
When the debt ceiling moratorium expired March, the debt ceiling came back in force. The US Government could no longer issue net new debt. It could only replace already outstanding debt. I wrote the following in the Liquidity Trader June Macro Liquidity report:
6/12/19 But for the time being, with the debt ceiling in place, the Treasury has not been issuing net new supply. So the line has turned flat since March, when the debt ceiling was reimposed. This will continue until the debt ceiling is lifted.
In addition, June 17 quarterly estimated tax receipts will result in Treasury paydowns for a couple of weeks. That will push the line higher as it injects cash back into the accounts of dealers and institutions. Offsetting that to some degree, the Fed will still be pulling money out of the market through August as continues its balance sheet normalization until then, albeit at a slower pace.
The market’s real problems will begin when the debt ceiling is lifted and the Treasury returns to the market with a vengeance. That supply will turn the line lower again.
So here we are. Congress and the Trump Regime have made a deal. The debt ceiling is going up.
Will animal spirits and burgeoning speculative leverage be sufficient to prevent the expected bearish outcome?
The M-FAT Indicator which I feature in Liquidity Trader Macro Liquidity reports is a composite of the impact of both the Fed and the US Treasury on the stock market. It correlated well with stock prices between 2007 and 2018. Logic suggested a cause and effect relationship.
Raising the Debt Ceiling Will Turn the M-FAT Lower
This indicator has been on a long term sell signal since March 2018. At the very least, this signal looked early. But is it completely wrong?
The imposition of the debt ceiling in March 2019 has helped the market dodge the bullet and extend the rally that began at year end 2018. The debt ceiling forced the reduction in new Treasury supply. That Coupled with paydowns of T-bills, that pumped cash into dealer and institutional investor accounts. Dealers and investors used some of that cash to buy stocks.
Raising the debt ceiling will allow the Treasury to come back into the market. It will initially need to issue several hundred billion in new supply to replenish the internal accounts it raided to maintain spending while the debt limit was in place. It will continue to need to issue more than $1 trillion per year in new debt after the initial surge.
When the Treasury sells new supply into the market it will resume putting downward pressure on the M-FAT. Stock prices are now extremely overbought relative to systemic liquidity (shown by the Composite Liquidity Indicator). They should follow the M-FAT trend lower, just as they did in 2008-09.
But as the current Liqudity Trader Macro Liquidity Report shows, there are other forces that could derail the expected outcome. Extreme self-reinforcing bubble mechanics are at work.
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