by David Brady
The Fed has now tapered liquidity injections to $80 billion per month in U.S. treasury bonds compared to rapidly rising government deficits and debt and the massive increase in the supply of bonds as a result. This is a significant drop in liquidity from the run-rate since March and clearly insufficient to cover the amount of bond issuance going forward. Simply put, the supply of treasury bonds relative to demand is falling unless other actors step up, such as foreign central banks who have been net sellers recently. Consequently, there is a growing risk of higher yields ahead.
The impact on stocks has been obvious. They peaked the day after the Fed’s announcement and have been weaker ever since. The announcement that they would be increasing the purchases of Corporate Bonds has caused a brief bounce, but stocks remain below their recent highs. The risk-reward has turned to the downside, in my opinion, until Fed turns on the hose of liquidity full blast again. I believe they will. It’s only a question of how low they allow stocks to go or how high bond yields. Then up we go to new all-time-highs.