Treasury Market About-Face: Just a Blip or Sign of Things to Come?

In my last article, I mentioned that the bulge in withholding tax collections that may have been a tipoff to the better-than-expected payrolls data had subsided (see Deconstructing the 'Massive Beat' in Employment Data). I took another look at the data today, and there's been no rebound since I posted that report.

 

 

On top of that, yesterday the Treasury announced that today's four-week bill auction would total $37 billion, which was not only the first time in seven weeks that it was more than $30 billion, it was a billion more than the new Treasury Borrowing Advisory Committee (TBAC) estimate for this quarter, on which the ink is barely dry.

 

The TBAC is a body that comprises a handful of the biggest of the Federal Reserve's primary dealers and is officially tasked with estimating the Treasury's quarterly borrowing needs and forecasting a weekly auction schedule, including types of securities and amounts expected for each. The TBAC issues a report every three months that I scrutinize closely and use as a benchmark for evaluating how things are unfolding week to week in terms of the reality versus the federal government's spin.

 

"Spin," by the way, is what the media pundits like to call it, but let's be real. "Spin," when applied to government pronouncements, is just a euphemism for wishful thinking and outright lying, in other words, propaganda. 

 

Over the past three weeks, total Treasury issuance was actually $37 billion below the TBAC forecast, thanks to the windfall withholding taxes that came along between the last week in December through the latter part of January. It's a very rare event indeed when the government actually does better than expected. It's usually a result of some kind of ham-handed manipulation.

The fact that this week the four-week bill size jumped by $7 billion and was more than the TBAC estimate is clear evidence that the benefits of the tax windfall, whatever its cause, have ended. In the end, the government's borrowing this week will be $4 billion more than the TBAC estimate, with a billion above forecast tacked on to each of the four bill auctions this week, from the four-week bill up to the 52-week bill. 

 

Now we can get back to the normal state in recent years where the government has been borrowing more than was expected every week, due to overly optimistic economic assumptions used by the government and the TBAC in making their forecasts. 

The Treasury market panic continued this week, with yields heading for new lows, thanks partly to a return of central banks to the table at a modest level, but mostly due to a ratcheting up of public buying. Bond fund inflows hit a record last week. It's sheer panic. Bedlam.

The panic atmosphere has been helped along by reduced supply. Once last Tuesday's big settlement (but less than originally forecast) was out of the way, the market just idled as the paper was digested. Supply settling next week will be extremely low, in fact, there should be a minor paydown. Then the mid month settlement will be well below the norm for note and bond settlements. Considering that the Fed usually settles a big wad of its forward MBS purchases at mid month, the skids will be greased and supply will be reduced. There will be more than enough cash to go around.

That will be a recipe for more buying of those "fortress balance sheet equities" (cough, cough), so the slow motion meltup will be spurred on, probably for most of February.

But something went wrong this week with that big surge of withholding tax collections we have been witnessing with awe. It disappeared. In fact, the year to year comparisons went negative again last week. The mystery money is gone, for now at least.
The Treasury Borrowing Advisory Committee, as is its wont, looked at the strong economic numbers of the past month or so and extrapolated them indefinitely into the future, forecasting big reductions in Treasury supply going forward. They even went so far as to suggest the Treasury allow negative interest rates on the bill auctions. Let the dealers and the big banks (of whom the TBAC guys are the kingpins) pay a kind of tax to the government for holding their money and keeping it "safe." I mean, these clowns are the biggest buyers of this paper. It's as if they want to kick themselves, or each other, in the ass. Of course, it will be grandma and grandpa saver who are hurt the most. But they don't count.

Plus, the Gummit and TBAC guys are apparently so confident that rates will stay down for the long run, they're talking about doing floating rate notes. They're now looking at a better than best case scenario. I suspect that things won't play out quite that way, especially if this sudden collapse in withholding taxes persists. Another week of disappearing taxes, and I'd take it seriously. So we'll watch out for that.

Remember, these are the same financial rocket scientist geniuses who built the credit bubble and collapsed the financial system. Since they paid no penalty for that, they will do it again, probably soon, is my guess.  The only issue is timing.
While we're waiting for the verdict on that though, there's enough momentum in the trends now at work to keep the bulls in clover for a few more weeks. 

The forces that had spurred last week's Treasury rally receded this week, with not only an increase in supply due to weaker-than-expected government revenues, but evidence in this week's auctions so far that investor demand, which had been running red hot, may be waning. The indirect bid, which is a measure of that demand both from investors and foreign central banks, has been down at each of this week's five auctions so far.

Three of the data series that we will want to look at closely this week are the Fed's weekly update on foreign central bank buying, the data from the Investment Company Institute on bond fund inflows, and the Fed's weekly data on commercial bank buying of Treasuries and Agencies. Those have all been positive in recent weeks. Any sign that any of them are on the wane could be the canary in the coal mine for a turn not only in the Treasury market, but also the stock market.