Buyers in equity markets have shown their strength. The SP500 added 0.4% on Monday. Futures on the index show an upward trend this morning, growing another 1.1%. This recovery did not fully offset the decline of previous days. However it pushes the same thoughts as last week, when we saw profit-taking after a firm April for the stocks.
Additionally, it is encouraging that the indices are growing quite evenly. Very often it is a sign of confident purchases for the long term rather than speculation on the latest news. Along with the growth of stocks, the dollar has turned to decline. It seems that the demand for dollars was satisfied.
The Fed has managed to quench the dollar thirst, and now reduces the volume of purchases on its balance. In the last two weeks of March, the balance sheet increased by $557B and $586B, while the latest data showed that it increased by “only” $83B. If you assess the actions of the Fed by the dynamics of the dollar, the US Central Bank managed with thin balance in its operations.
However, the financial system is movable. And now there is a new, no less stressful test coming. The US Treasury Department is going to attract about $3 trillion in the second quarter of the year in its updated borrowing plans. This is five times higher than the previous quarterly record in 2008.
The big question now is what impact this will have on the markets. Historically, such situations have been negative for the markets, as investors will prefer highly reliable US government securities to riskier stocks. On a much smaller scale, this happened in September last year. Back then, the Fed was helping markets by injecting liquidity and can do so now, again dramatically increasing asset purchases on the balance sheet. This is not the only case. The US Treasury bills are regularly placed on a large scale, and the dollar is strengthening. It is an approach based on history.
But there is another approach, the one based on the logic. Besides the US Treasury offer, US bonds government bonds are thrown into the market by many EM countries, that sell their FX reserves to help the economy and keep national currencies from free fall. It may well turn out that the dollar debt may be too large in the markets. In this case, the value of dollar debt may begin to decline, because there will be too much of it.
However, the Fed only comes into play when the situation gets out of control. Will, the US Central Bank, act proactively this time, or will we see signs of a significant shift in balance before the regulator intervenes? Either way, this impending debt placement tsunami is unlikely to be quiet.
