Both banks and foreign central banks (FCBs) have normal buying cycles, and last week’s evidence suggests that both are just past the peak of those cycles. In addition, because of Japan’s predicament, FCB buying is for the foreseeable future likely to be well below the necessary levels to keep levitating stocks. Add to that the loss of the 2 month long, $25 billion weekly stipend from the Treasury on March 24, and we have the conditions for a rough patch.
With less help from the Treasury, the banks, and FCBs, the Fed would have its hands full keeping all its balls in the air. Some would be likely to hit the ground, but not this month. That’s because of the light Treasury supply that I covered in the Treasury update. That makes the job much easier this month, even without the banks and the FCBs.
This week is one of those easy weeks, with lots of Fed pumping and no new Treasury supply. That should be relentlessly bullish, but you sure wouldn’t know that from Monday’s action. There’s tremendous drag behind the scenes that is preventing the Fed’s pumping from having as much effect is it would otherwise.
The evidence shows that banks are again out of the Treasury buying game. It also shows that they lost money in the first quarter, which is insane considering that their cost of funds is zero. It’s an indication of just how dire the circumstances are. Banks continue to accumulate cash at a frantic rate in their accounts at the Fed. The last time reserves rose this fast was in the midst of the crisis in 2008.
Although the banks did buy some Treasuries in mid March, they have again stopped buying and reduced their holdings, opting to hold cash at the Fed instead. The banks are pulling cash out of the system and depositing it in their reserve accounts even faster than the Fed is printing it, lately 60% faster. We have to wonder what has them so spooked.
At the same time, FCB purchases of Treasuries are also backsliding, and are well below the threshold where they need to be to keep the markets stable.
These elements essentially neutralize the Fed’s pumping. It may not be enough to send the markets lower, and in the absence of new Treasury supply, Fed buying should be enough to keep the field tilted in favour of higher prices. April’s bias should be to the upside, but the background drag will be there. Things will get tougher in May when Treasury supply increases, and really tough this summer when the Fed presumably will stop pumping. The question at that point is to what extent the banks and FCBs will be on the upside of their buying cycle, and will that alone be enough to prevent a selloff.
In the meantime I would not wait to “sell in May and go away.” April looks like a good time to scale out of all equity longs, including in particular broad based ETFs, like SPY, DIA, QQQ, and IWM. Aggressive traders and hedgers can use strength to establish short positions probably around mid month and after.
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