Doc's Daily Commentary

Mind Of Mav

Death Of The Dollar Standard Part 4

“Without the Fed, yields would skyrocket”

This is wrong. The Fed has been keeping their basic level QE of 120 billion per month for months now. But ignoring the fake breakout at the beginning of June (thanks to reopening hopes), yields have been on a steady decline.

Let’s take a look at the Fed’s balance sheet.

The Fed has thankfully stayed away from purchasing more treasury bills (short term treasury securities). Bills are important for the repo market as collateral. They’re the best collateral you can have and the Fed has already done enough damage by buying those treasury bills in March, destroying even more liquidity than usual.

More interesting is the point “notes and bonds, nominal”. The Fed added 13.691 billion worth of US treasury notes and bonds to their balance sheet. Luckily for us, the US Department of Treasury releases the results of treasury auctions when they occur. On July 28th there was an auction for the 7-year treasury note. You can find the results under “Note -> Term: 7-year -> Auction Date 07/28/2020 -> Competitive Results PDF”. Or here’s a link.

What do we see? Indirect bidders, which are foreigners, by the way, took 28 billion out of the total 44 billion. That’s roughly 64% of the entire auction. Primary dealers are the ones that sell the securities to commercial banks. Direct bidders are domestic buyers of treasuries.

The conclusion is: There’s insane demand for US treasury notes and bonds by foreigners. Those US treasuries are basically equivalent to US dollars. Now dollar bears should ask themselves this question: If the dollar is close to collapse and the world wants to get rid fo the US dollar, why do foreigners (i.e. foreign central banks) continue to take 60-70% of every bond auction? They do it because they desperately need dollars and hope to drive prices up, supported by the Federal Reserve itself, in an attempt to have the dollar reserves when the next liquidity event occurs.

So foreigners are buying way more treasuries than the Fed does. Final conclusion: the bond market has adjusted to the Fed being a player a long time ago. It isn’t the first time the Fed has messed around in the bond market.

How market participants are positioned

We know that commercial banks made good money trading bonds and stocks in the past quarter. Besides big tech, the stock market is being stagnant, plain and simple. All the stimulus, stimulus#2, vaccinetalksgoingwell.exe, public appearances by Trump, Powell, and their friends, the “money printing” (which isn’t money printing) by the Fed can’t continue to push SPY back to ATH time after time.

Who can we look at? Several people — but let’s take Bill Ackman. The one who made a killing with Credit Default Swaps in March and then went LONG (he said it live on TV).

Well, there’s an update about him: Bill Ackman saying he’s effectively 100% long

He says that around the 2-minute mark.

Of course, we shouldn’t just believe what he says. After all, he is a hedge fund manager and wants to make money. But we have to assume that he’s long at a significant percentage – it doesn’t even make sense to get rid of positions like Hilton when they haven’t even recovered yet.

Then again, there are sources to get a peek into the positions of hedge funds, let’s take Hedgopia.

We see: Hedge funds are starting to go long on the 10-year bond. They are very short the 30-year bond. They are very long the Euro, very short on VIX futures and short on the Dollar.

Endgame

This is the perfect setup for a market meltdown. If hedge funds are really positioned as Ackman and Hedgopia describe, the situation could unwind after a liquidity event: The Fed increases QE to bring down the 30-year yield because the economy isn’t recovering yet. We’ve already seen the correlation between QE and USD and QE and bond prices. That causes a giant short squeeze of hedge funds who are very short the 30-year bond. They need to cover their short positions. But Ackman said they’re basically 100% long the stock market and nothing else. So what do they do? They need to sell stocks. Quickly. And what happens when there is a rapid sell-off in stocks? People start to hedge via put options. The VIX rises. But wait, hedge funds are short VIX futures, long Euro, and short DXY.

To cover their short positions on VIX futures, they need to go long there. VIX continues to go up and the prices of options go suborbital (as far as I can see). Also, they need to get rid of Euro futures and cover their short DXY positions. That causes the USD to go up even more.

And the Fed will sit there and do their things again: more QE, infinity QE^2, dollar swap lines, repo operations, TARP, and whatever else they introduce. The Fed will be helpless against the forces of the market and have to watch the stock market burn down and they won’t even realize that they created the circumstances for it to happen – by their programs to “help the economy” and their talking on TV. Do you remember JPow on 60minutes talking about how they flooded the world with dollars and print it digitally? He wanted poor people to believe that the Fed is causing hyperinflation and we should take on debt and invest in the stock market. After all, the Fed has it covered.

But the Fed hasn’t got it covered. And Powell knows it. That’s why he’s being a bear in the FOMC statements. He knows what’s going on. But he can’t do anything about it except what’s apparently proven to be correct – QE, QE, and more QE.

A final note about “stock market is not the economy”

It’s true. The stock market doesn’t reflect the current state of the economy. The current economy is in complete shambles.

But a wise man told me that the stock market is the reflection of the first and second derivatives of the economy: velocity and acceleration of the economy.

In retrospect this makes sense.

The economy was basically halted all around the world in March. Of course, it’s easy to have an insane acceleration of the economy when the economy is at 0 and the stock market reflected that. The peak of that accelerating economy (“max velocity” if you want to look at it like that) was at the beginning of June. All countries were reopening, vaccine hopes, JPow injecting confidence into the markets, etc.

Since that time, the S&P has been stagnant, IWM/RUT (arguably one of the best reflections of the actual economy) has slightly gone down, and people have bid up tech stocks in absolute panic mode.

Even the Fed has admitted it as recently as last week.

The economic recovery has slowed down and if we look at economic data, the recovery has already stopped completely. The economy is rolling over as we can see in the continued high initial unemployment claims.

TLDR and positions or ban?

TLDR: Global economy bad and there is still a dollar shortage. The economy is not recovering while the Fed is back to doing QE Infinity. QE Infinity will cause the final squeeze in both the bond and stock market and will force the unwinding of the whole system.

 

 

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