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Foreign Central Bank Buying Drives The US Stock Market 10/23/04

Sufficient demand to drive expansion of the bubble will only be forthcoming if rates continue to fall. The demand for credit at rates at, or above, current levels has been met. Further declines are only likely if foreign central banks keep the US government on the dole. There have been signs at recent Treasury Suctions that they may be pulling the plug, or at least cutting back. Recently as well, the Fed's custodial holdings for foreign governments has stopped growing, an indication that Uncle Fukui, Uncle Dung and others are slamming on the brakes. What does that matter? Simple. Without the subsidization of our markets by foreigners, in particular the central banks of Japan and China, and organizations like OPEC, the prices of US financial assets, in particular stocks, will fall. 

The Fed reports every Thursday night the dollar value of US government securities it holds in custody for foreign central banks and international organizations such as OPEC. Changes in the level of these custodial holdings reflects the buying of Treasuries by Uncle Fuku, Uncle Dung, et. al.  The correlation between foreign central bank buying of Treasuries and the performance of US stock prices is direct and undeniable, as the chart below illustrates. Since May of 2003 the SPX has directly mimicked the 8 week moving average of the 4 week rate of change in the Fed's foreign custodial holdings.

The US gummit, thieving corporations, thieving corporate insiders, and the Wall Street distribution machine are creating such an enormous supply of securities all the time, that unless foreign central banks continue to add to their holdings at an annualized rate of increase of 30% or so, there is not enough demand to support all the new toilet paper flooding the market. To those who say that our foreign benefactors will keep this up indefinitely I say, Gimme a break! The evidence of the last 6 months says that either they will not, or they cannot.

Consumer borrowing, (and hence, consumer spending) is beginning to break down

When the cash from the refi bulge came through between March and May, consumers reduced their direct unsecured borrowing. That ended May 12, at a real estate loans peak. Consumers then went on a credit card binge. The record for this series was set on June 16, at $678.7 billion, up 7% in the prior 12 months. Since then the trend has been flat, raising the question of whether consumers are just taking a breather or are finally tapped out. That question was answered this week. Meanwhile, economists were surprised that total consumer debt was down as reported in early October. What were they looking at? It was clear from the weekly commercial banking data, what was going on. 

Chart adjusted for asset reclassification in July 2004, and an 11/03 anomaly. 

This chart includes all consumer debt, reported monthly. 
Chart: Total Consumer Credit Outstanding
Chart: Total Consumer Credit Outstanding

Money Supply Stall

Bank Credit Still Rising, But Pace Has Slowed

The stock market peaked in late February when the rate of credit growth peaked. A 5% growth rate in total credit is not enough to keep stock prices inflated and it's not enough to keep the money supply growing.

Based on the divergence between increasing total bank credit, and the flat money supply, we know there's a leak somewhere. A line in the bank data gives us a near real-time window where it might be. Holdings of federal agency MBS by large commercial banks were down in the week ended 10/13 continuing a downtrend which began in April. In fact, if we take out the large spikes, in April of 2003 and February 2004, which probably represented large sales to the large commercial banks, from non-banks, then this series would have already broken the 3 year uptrend. The same thing was certainly happening with the GSE's, only on a much large scale, explaining why recently surging bank credit is not showing up in the money supply. Now that Fannie is being forced to shed holdings, we wonder who will pick up the slack. Certainly not the commercial banks. That leaves foreign and domestic investors. Hmmmm. 

The failure of the money supply to move very much on the recent expansion of credit in the banking system suggests that the real engine of money creation, GSE mortgage credit, which is not reflected in banking data, may be faltering. We were talking about this before the OFHEO report on the problems of FNMA became public. The MoGauge has been sputtering for months. Actual retained portfolio data from the GSE's themselves is only released with a 6 week lag, (Fannie, Freddie) so it is not of much help in terms of what's happening in real time. The announcement that Fannie will have to hold higher cash reserves is the precursor to tighter liquidity in general. 

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