Is Fed Playing Cat And Mouse With Investors?

Finally, while I’ve been warning for some time that the Fed’s daily reverse repurchase agreements are the fundamental equivalent of a shadow taper (though, it doesn’t have the same psychological effect), the Fed sold $776.261 billion worth of reverse repos on Jul. 15 and $859.975 billion worth of reverse repos on Jul. 14. More importantly, though, with the U.S. 10-Year Treasury yield often moving inversely of the Fed’s international reverse repos, bond investors are behaving as if the taper is already underway.

Please see below:

To explain, the dark blue line above tracks the quarterly percentage change in the U.S. 10-Year Treasury yield, while the light blue line above tracks the Fed’s inverted (scale flipped upside down) international reverse repos. If you analyze the relationship, you can see that the larger the liquidity drain, the more bond investors position for slower growth, lower inflation, and a hawkish Fed.

Conversely, the dynamic has the opposite effect on the USD Index. With U.S. dollars being siphoned out of the system, it’s akin to the Fed reducing its QE program. As such, the liquidity drain (lower supply of dollars) is extremely bullish for the greenback.

In conclusion, while the PMs have been buoyed by falling real yields, their relative performance has been extremely subdued. From March through May, gold rallied sharply once the U.S. 10-Year real yield reversed course. This time around, however, the bounce has been tepid, as concerns over a prospective taper counter the bullish optimism. As a result, with the USD Index gaining steam, inflation surging and a taper announcement likely to commence in September, the PMs’ optimism could evaporate at the drop of a dime. Thus, it’s prudent to avoid reading too much into their recent strength.

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Disclaimer: All essays, research and information found on the Website represent the analyses and opinions of Mr. Radomski and Sunshine Profits' associates only. As such, it may prove wrong ...

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