Nice post to end the year with. 2023 should prove to be damn interesting.
A couple of points:
1. Regarding footnote 5. Its actually the principal from prepaying mortgages that makes up the majority of monthly MBS payments to the FED. The principal portion of regular mtge payments is ~5b/mnth on the FEDs 2.6T MBS portfolio, thus prepayments accounted for ~12b of the FEDs MBS reduction this month. Prepayments used to dominate much more before mtge prepayments speeds collapsed. Since the 5b/mnth for regular principal payments is close to static, when the FED was receiving 40b/mnth in MBS payments (early last spring) the split was more 5/35. Sorry for the nitpick but thought you and your readers might find the nuance interesting.
2. Treasury's payments to the fed to payoff UST maturities each month is debt ceiling neutral I believe since regardless of whether its the FED (reinvestment above the QT cap) or rest of market (up to the 60b cap) that funds the rollover, from a debt ceiling perspective its maturing debt so Treasury can reissue the same amount of debt without impacting the debt ceiling number. So I think its really the deficit spending (including servicing costs for existing debt) that drives the TGA drawdown once the debt ceiling is hit and the only new debt Treasury can issue is rollover of maturing debt (in amounts anyways composition of the new vs. maturing debt may change e.g. Bills -> coupons to keep the coupon issuance schedule)
3. One thing to account for on when the TGA will exhaust in the absence of a ceiling hike is tax receipts. My general understanding is they are heavier through April/May which would offset pressure on the TGA drawdown for a bit and may explain why many estiamtes dont anticipate exhaustion until Q3
4. My last point is more a question. What is the causal relationship (if any) between base money "liquidity" and equity prices/S&P level. Defining base money "liquidity" as more or less the level of bank reserves (total FED B/S liabilities - (TGA + RRP) ) given that currency is pretty constant. I recognize the clear correlation between the two over the past 2 years but I can think of no logical causation. I would love to hear any thoughts you have on that causation or lack thereof. Perhaps an article topic for sometime in 2023.
Thank you TLBS for all you have shared with us this past year! It is fabulous content and very much appreciated.
1. Good point on refi's vs. regular payment - on the verge of nitpicky but I love it! In the future will draw this distinction.
2. Again - a great point to draw, that should have been addressed more directly in the piece. You are right that the QT repayments are debt ceiling neutral by themselves, just as the treasury can continue to roll over maturing debt. (Though its worth noting that it still amounts to a draw on private sector liquidity). The debt ceiling limits "net new issuance" which as you mention would be driven by the deficit and perhaps higher rates on rolled debt. If you consider that the deficit is expected at $1.2Tr - that translates to $100b/month of deficit spending that will be paid out of cash on hand rather than new debt which still leads to the ultimate liquidity effect I alluded to. In other words, the cash is fungible - its all about total sources and uses. The TGA and will continue to drawdown and offset QE for the private market. But I agree the article is a bit misleading in how its described.
3. Yes April of course is a huge month for receipts (December and January are also often strong as well). I buried this one in a footnote, because I wasn't ready to trot out my math in public, since it truly is challenging to put it all together. And from what I can tell, nobody seems to have a precise handle on it. FWIW the deficit for the first two months of the 2023 fiscal year have come in about 20% higher than 2022.
4. The last question is great. I know that a lot of people have shown the correlation over the past 2 years and it's hard to deny that they seem to move in tandem. But! if you look back further, you see that the correlation is not nearly as neat. In the last QT cycle ('17-'19) liquidity fell consistently and the market rose. Again during early 2020, liquidity was rising the entire time, but it didn't prevent a 35% drawdown in a month.
Its probably worth a full post but my best guess what I described in The Pool (https://thelastbearstanding.substack.com/p/the-pool). If the Fed is injecting base money via QE, that means that someone is selling a non-cash asset (UST/MBS) for cash, and the whole ecosystem receives +$1 of cash. That seller may be selling bonds to buy stocks, so that +$1 goes and bids up stocks, and so on...
Thanks again for these great comments, and keeping me honest on my analysis.
I just gotta laugh at these yearly debt ceiling shenanigans. Congress has no intention of ever limiting their spending or paying any debts. Even if it was 100% true republicans, the spending would go on and on and on...
Forget the Fed. Real rates should be in the 7-10% range at least and maybe over 12%. The entire rate scheme and financial system is now so convoluted and contorted that reality has become inaccessible. Thus, at some point it will rear its head and make up for all the sins of the Fed placating to the top 5%.
We had the opportunity to clear the decks of much of the corruption and rubbish in the 2008-2010 period, but the Fed went chicken and now we are in a much worse place. It's not gonna be pretty but we are close to the point of no return.
Happy and healthy new year to you and your family. As always I enjoy all of your articles. I question where you place your extra money given the current bear market?
Money markets are a good option. Compare the best rates. But their rates can change at short notice, which can be a pain. Since the beginning of this year, I set up several staggered 4-month and 6-month duration CDs yielding 3.2 and 3.5%. But I will cash out gradually to be in cash again by mid-2023, so I can get back into the market 100% again, hopefully before 2024 comes around. I know one shouldn't time the market, but the 2021 and 2022 valuations were just too insane for me to sit this one out. I sold out of my ETFs in Sept. 2021, and I'm glad I did.
Yes, plus you can max out yield buying 6m- 1-2yr treasury’s but for the average person I doubt the bps are material and the benefit of being to step in and out on a daily basis is very nice
TLBS, thanks for the "tour"! I've been looking for a high quality article on this topic. While this article is now more than 3 months old, it is only growing in importance, as the deadline looms ever closer. The funny thing is that the MSM isn't talking much about the liquidity consequences, which you might think would be a hot topic that complements the banking crisis / emerging credit crunch.
Once again, I understand that I know very little about the financial sausage works. I’m late to this party but wanted to let you know that I have enjoyed the content in 2022 and look forward to being an avid “like the post” guy throughout 2023. Happy new year TLBS
Nice post to end the year with. 2023 should prove to be damn interesting.
A couple of points:
1. Regarding footnote 5. Its actually the principal from prepaying mortgages that makes up the majority of monthly MBS payments to the FED. The principal portion of regular mtge payments is ~5b/mnth on the FEDs 2.6T MBS portfolio, thus prepayments accounted for ~12b of the FEDs MBS reduction this month. Prepayments used to dominate much more before mtge prepayments speeds collapsed. Since the 5b/mnth for regular principal payments is close to static, when the FED was receiving 40b/mnth in MBS payments (early last spring) the split was more 5/35. Sorry for the nitpick but thought you and your readers might find the nuance interesting.
2. Treasury's payments to the fed to payoff UST maturities each month is debt ceiling neutral I believe since regardless of whether its the FED (reinvestment above the QT cap) or rest of market (up to the 60b cap) that funds the rollover, from a debt ceiling perspective its maturing debt so Treasury can reissue the same amount of debt without impacting the debt ceiling number. So I think its really the deficit spending (including servicing costs for existing debt) that drives the TGA drawdown once the debt ceiling is hit and the only new debt Treasury can issue is rollover of maturing debt (in amounts anyways composition of the new vs. maturing debt may change e.g. Bills -> coupons to keep the coupon issuance schedule)
3. One thing to account for on when the TGA will exhaust in the absence of a ceiling hike is tax receipts. My general understanding is they are heavier through April/May which would offset pressure on the TGA drawdown for a bit and may explain why many estiamtes dont anticipate exhaustion until Q3
4. My last point is more a question. What is the causal relationship (if any) between base money "liquidity" and equity prices/S&P level. Defining base money "liquidity" as more or less the level of bank reserves (total FED B/S liabilities - (TGA + RRP) ) given that currency is pretty constant. I recognize the clear correlation between the two over the past 2 years but I can think of no logical causation. I would love to hear any thoughts you have on that causation or lack thereof. Perhaps an article topic for sometime in 2023.
Thank you TLBS for all you have shared with us this past year! It is fabulous content and very much appreciated.
Happy New Year,
John
Thanks John, Great points as always.
In response:
1. Good point on refi's vs. regular payment - on the verge of nitpicky but I love it! In the future will draw this distinction.
2. Again - a great point to draw, that should have been addressed more directly in the piece. You are right that the QT repayments are debt ceiling neutral by themselves, just as the treasury can continue to roll over maturing debt. (Though its worth noting that it still amounts to a draw on private sector liquidity). The debt ceiling limits "net new issuance" which as you mention would be driven by the deficit and perhaps higher rates on rolled debt. If you consider that the deficit is expected at $1.2Tr - that translates to $100b/month of deficit spending that will be paid out of cash on hand rather than new debt which still leads to the ultimate liquidity effect I alluded to. In other words, the cash is fungible - its all about total sources and uses. The TGA and will continue to drawdown and offset QE for the private market. But I agree the article is a bit misleading in how its described.
3. Yes April of course is a huge month for receipts (December and January are also often strong as well). I buried this one in a footnote, because I wasn't ready to trot out my math in public, since it truly is challenging to put it all together. And from what I can tell, nobody seems to have a precise handle on it. FWIW the deficit for the first two months of the 2023 fiscal year have come in about 20% higher than 2022.
4. The last question is great. I know that a lot of people have shown the correlation over the past 2 years and it's hard to deny that they seem to move in tandem. But! if you look back further, you see that the correlation is not nearly as neat. In the last QT cycle ('17-'19) liquidity fell consistently and the market rose. Again during early 2020, liquidity was rising the entire time, but it didn't prevent a 35% drawdown in a month.
Its probably worth a full post but my best guess what I described in The Pool (https://thelastbearstanding.substack.com/p/the-pool). If the Fed is injecting base money via QE, that means that someone is selling a non-cash asset (UST/MBS) for cash, and the whole ecosystem receives +$1 of cash. That seller may be selling bonds to buy stocks, so that +$1 goes and bids up stocks, and so on...
Thanks again for these great comments, and keeping me honest on my analysis.
I hope you have a great new year as well.
TLBS
Great article as always, very insightful about the mechanics between the treasury the fed and the markets.
Wish you a great 2023!
Thanks Matias! Hope you have a great new year.
I just gotta laugh at these yearly debt ceiling shenanigans. Congress has no intention of ever limiting their spending or paying any debts. Even if it was 100% true republicans, the spending would go on and on and on...
Forget the Fed. Real rates should be in the 7-10% range at least and maybe over 12%. The entire rate scheme and financial system is now so convoluted and contorted that reality has become inaccessible. Thus, at some point it will rear its head and make up for all the sins of the Fed placating to the top 5%.
We had the opportunity to clear the decks of much of the corruption and rubbish in the 2008-2010 period, but the Fed went chicken and now we are in a much worse place. It's not gonna be pretty but we are close to the point of no return.
What an article TLBS! Love to always learn from your writings, just came to say thank you and happy new year!!
Thanks Alexr! Happy new year to you!
I found your Substack this year and it has been an absolutely gem! Thank you for your content and have a wonderful new year!
Thanks Sidd, Im glad you have enjoyed reading, and hope you have a wonderful new year as well.
Great article!
Happy new year to you and your family!
Thanks Cesar! to you as well.
Happy and healthy new year to you and your family. As always I enjoy all of your articles. I question where you place your extra money given the current bear market?
Money markets pay 4% with almost no risk. People would kill for that yield a year ago. Not a bad place to sit and wait for opportunity
Money markets are a good option. Compare the best rates. But their rates can change at short notice, which can be a pain. Since the beginning of this year, I set up several staggered 4-month and 6-month duration CDs yielding 3.2 and 3.5%. But I will cash out gradually to be in cash again by mid-2023, so I can get back into the market 100% again, hopefully before 2024 comes around. I know one shouldn't time the market, but the 2021 and 2022 valuations were just too insane for me to sit this one out. I sold out of my ETFs in Sept. 2021, and I'm glad I did.
Yes, plus you can max out yield buying 6m- 1-2yr treasury’s but for the average person I doubt the bps are material and the benefit of being to step in and out on a daily basis is very nice
TLBS, thanks for the "tour"! I've been looking for a high quality article on this topic. While this article is now more than 3 months old, it is only growing in importance, as the deadline looms ever closer. The funny thing is that the MSM isn't talking much about the liquidity consequences, which you might think would be a hot topic that complements the banking crisis / emerging credit crunch.
Once again, I understand that I know very little about the financial sausage works. I’m late to this party but wanted to let you know that I have enjoyed the content in 2022 and look forward to being an avid “like the post” guy throughout 2023. Happy new year TLBS
Thanks Scott! I’m glad you’ve enjoyed it so far, and looking forward to a great year ahead. Thanks again for reading!