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The US is in MASSIVE trouble.

So JC's charts that I posted yesterday indicate or suggest that this is a bull market. That all is well. Nothing could be further from the truth. Exactly like in 1969, 2000, 2008, 2020, the signs and the FACTS are present, to indicate that there are some really serious issues that the market has definitely not priced in.

So Yellen's issue is definitely one of them. It ties into this debacle in the following way:

[ATTACH=full]191510[/ATTACH][ATTACH=full]191509[/ATTACH][ATTACH=full]191508[/ATTACH]

So expenses are rising. Receipts are falling.

The difference comes from where?

To date:

[ATTACH=full]191507[/ATTACH]

Which as you can see is almost drained.

What is left is:

[ATTACH=full]191512[/ATTACH]

This is how Yellen worked due to Powell, who hates her guts, continuing to shrink the money supply via Fed QT.

Worse than projections of fewer rate cuts is a constantly shrinking money supply: Powell continues to reduce the Fed’s balance sheet by $20 billion per week. Since Silicon Valley Bank was bailed out in early 2023, the Fed’s balance sheet has fallen $1.9 trillion, from $8.7 trillion to $6.8 trillion, a reverse QE that should be slaughtering stocks and credit markets. The reason the market is still frothy is that, also in 2023, Janet Yellen discovered that the Treasury could do its own stealth QE to counter balance the Fed.

To explain: Powell printed $5 trillion in response to COVID, but he also offered banks an above-market interest rate for them to deposit funds directly at the Fed’s reverse repo facility, attracting $2.3 trillion that remained out of circulation. Yellen figured out that, whereas banks and money-market funds would never withdraw overnight funds from the Fed to buy, say, a 10-year Treasury bond, they would do so to buy 3-month Treasury bills if the yield were slightly more attractive.

Normally, the Treasury raises between 15% and 20% of the money required for federal government deficit spending by offering short-term Treasury bills (maturities less than a year), the remainder in longer-term notes and bonds. But in Q4 2023, Yellen financed the deficit with a mix of 60% bills; in Q1 2024 it was 57% bills, and 34% in Q3 2024.

This massive bill issuance increased supply well beyond market expectations, lowering prices, and raising short yields enough to draw cash out of the Fed: the reverse repo cash facility plunged from $2.3 trillion in April 2023 to $178 billion on January 10, 2025 or $200 billion more than the Fed’s balance sheet runoff. Yellen’s policy also had the effect of issuing fewer long-term bonds than expected, which supported their prices, creating artificially lower rates in the 10-year bond, which is the reference point for mortgages and other long-term credit.

Now Trump’s anointed Treasury Secretary Scott Bessent must decide how to roll the $6.7 trillion in Treasury bonds coming due in 2025. He is well aware of the problem, having written about it in his investor letter dated January 31, 2024:

We believe that the Treasury had become uncomfortable with the bond market sell-off to date and the tightening of financial conditions that resulted. As such, even though it would be more expensive to fund via Treasury bills given the deeply inverted yield curve, the Treasury decided it was a price worth paying. Over the short-term, this change in issuance strategy has had the desired effect, with financial conditions easing materially since the November 1 announcement. However, over a medium-term horizon, we believe this is a risky strategy, and it comes with significant costs. In addition to a higher interest expense, concentrating issuance in short tenors exposes the Treasury to greater volatility via refinancing risks and creates the potential for a financial accident. 

If Bessent reverts to standard Treasury practice, issuing only 15%-20% in bills, the 10-year financing reference rate will drift higher, and a falling short-term rate risks enticing money back into the Fed’s reverse repo facility, sending a tightening shock through markets and the economy. Even if he were to continue Yellen’s policy, she has timed it such that the reverse repo facility is drained—the Treasury no longer has much ability to neuter the Fed’s balance sheet shrinkage.

 

Yellen also left this stink bomb for the new administration—in a letter to Congress dated December 27, she wrote, which is where the Zero Hedge article comes in:

As you know, the debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments. In June 2023, the Fiscal Responsibility Act of 2023 was enacted, suspending the debt limit through January 1, 2025…Treasury currently expects to reach the new limit between January 14 and January 23, at which time it will be necessary for Treasury to start taking extraordinary measures. 

As a reminder, the Trump administration begins on January 20. And, just to make it more fun for Bessent, Yellen is spending down the Treasury’s cash account at the Fed, which has fallen from $842 billion on November 6 to $652 billion as of January 10.

Just as Trump takes office, the main sources of liquidity are going into reverse: short rates will be higher than expected as Powell turns hawkish, long rates will rise due to federal financing needs and also because of the need to address Yellen’s abnormal maturity mix, the money supply will shrink because there is no more ability for the Treasury to undo Powell’s balance sheet runoff, the money supply will shrink faster if funds start moving back into the Fed’s reverse repo facility.

So exactly like in 2008 when 'everyone' knew that the teaser mortgage rates were going to reset higher, everyone knows that rates need to reset due to the tsunami of debt, $7 trillion that needs to be rolled over, yet, the market continues to power higher.

There are a few reasons underpinning:

(i) Passive flows are insensitive to market conditions, valuations or anything;

(ii) Stock buybacks to offset Option issues to the C-suite

(iii) Capitulation of Short Sellers, Jim Chanos, this week Hindenberg, pretty much every short seller of note.

JC's warning sign, although he did not pitch it as a warning sign, rather he poured scorn on them:

[ATTACH=full]191513[/ATTACH]

These are not individuals, these are larger players pulling out. Buffett cleaned house at the end of last year.

We are in a massive, multi asset bubble. Bubbles do not end well. But going short a bubble too early is also fatal. Therefore, currently, you have to be long. But long with such a light touch that you can exit or reverse very, very quickly.

jog on

duc