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Pundits Expecting More QE Are Wrong


Liquidity indicators are bullish, and any initial market disappointment in the face of 'no new QE' will quickly be shrugged off.

Those who don't know me well have sometimes accused me of being a permabear. Those of you who do know me via my articles know that I always strive to be "fair and balanced."

I think this article exemplifies that high ideal. It's as bullish as I've ever been, and yes, maybe I should be faded when I start "pounding the table" like this. But I'm only pounding on what the indicators are showing. There's certainly no personal bias in this direction. My bias is only to follow the indicators, regardless of what mayhem or foolishness they may be pointing toward.
I don't like this, but it is what it is. The world financial system is overmanipulated. But sometimes manipulation works, sometimes it has unintended consequences that benefit one party over another, and sometimes the US gets the roses while the rest of the world sinks into the sludge that most of the pundits and government manipulators are worried about. This is one of those times, and herein is its story.

Take this story and do with it as you wish. If you think it's wrong, I'd love to hear from you as to why. The easiest way to do that is to leave a comment in the comment section.

Liquidity flows in the US branch of the system have been turning more bullish in recent weeks. Several indicators that had been neutral or bearish have turned bullish, joining deposit flows into the US banking system (apparently from EU), which have been the lead bullish sled dog for a while.

In this liquidity-based model of the market, there is no way the markets can decline as long as this continues. It forces us to assume that the bias will remain to the upside. Meanwhile, the Federal Reserve continues to quietly tap the brakes, without explanation or comment, while the money supply explodes. The Fed is transparent only when attempting to jawbone the market higher. Anything that might run counter to that, and it shuts up tight as a clam.

The media has been rife with speculation that the Fed is on the brink of another massive quantitative easing. Given the rapid growth of the money supply, the recently strong stock market performance, the surging federal withholding taxes, and improvement in other economic indicators, it's hard to see justification for the Fed to make such a move. The Fed is well aware that additional QE would be likely to set commodities off on another tear that would be self-defeating for the economy.

I'd have to guess that the pundits looking for another QE at this week's meetings are wrong, but it doesn't matter. The markets follow the money. My guess is that any initial market disappointment in the face of "no new QE" would quickly be shrugged off. If I'm wrong and the Fed announces or hints at additional QE, I'd watch the commodities and hitch a ride if I liked moon-shot roller coasters.

In the meantime, the liquidity indicators are strengthening. Bank deposit net inflows continue. Fed pumping of cash to Primary Dealers remains in a bullish trend and will continue to as long as the mortgage-backed securities replacement program remains in effect, which will be until midsummer unless the Fed makes a course change before that.

Those flows will slow drastically if Treasury rates rise, but due to the delayed settlements of the Fed's MBS purchases, the impact of that reduction won't be felt until April or May at the earliest. Meanwhile Treasury supply looks likely to be lighter than expected.

Foreign central bank purchases of Treasuries and Agencies turned bullish last week. Their trend has improved from a bearish to a neutral influence. The trend of reserve and other deposit levels at the Fed have been stable and are thus a neutral market influence. Banks bought Treasuries last week, and the trend of that indicator has turned unequivocally bullish. Bank non-Treasury trading accounts were little changed last week, but that trend is also bullish.

The composite liquidity indicator upticked last week, slightly breaking the November 2011 peak in the process. The indicator now has a slight uptrend since last summer. The performance of stocks and bonds has been consistent with that. Recent behavior of the components and typical cyclical patterns suggest that some degree of strengthening is likely to continue in the weeks ahead. That should be bullish for stocks, especially if Treasury market inflows begin to wane, as last week's signals suggest they may.

Finally, for whatever reason, stock prices have tracked the Fed's actions, and Treasury prices have more closely tracked the European Central Bank's moves in recent years. That stands to reason as investors in European debt have sent cash pouring into the US, particularly via purchases of Treasuries, whenever the ECB has provided the funding to do so.

But it is notable that US stock prices seem to also be getting the benefit of the most recent ECB-pumping operations. If another massive ECB long-term refinancing operation is indeed forthcoming, as many are speculating, that could blow the roof off the US market in the weeks ahead.

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Twitter: @Lee_Adler
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No positions in stocks mentioned.

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