Here’s the Foreign Country That’s Rigging Our Markets (It’s Not Russia)

Lee AdlerLee Adler

Today, I bring you a juicy piece of foreign intel from my weekly analysis at The Wall Street Examiner Pro Trader. While this is intriguing information, it’s not dangerous. Yet.

But once the chart I’m about to show you drops below 440, it will have an immediate impact on your portfolio.

Let’s start with a broader look at the atrocious foreign central bank behavior that has been contributing to the dangerous excesses that have built up in the U.S. stock market. Then I’ll close in on the one country that’s likely to ruin us.

Foreign Central Banks (FCBs) Are About to Pull Our “Money Plug”

FCB purchases of securities under their QE programs inject cash into the U.S. system. That’s because the same big dealers are trading partners with all major central banks and in all major markets. For example, when the ECB buys European bonds from a dealer or bank, those players can use that cash to buy whatever they want, including U.S. Treasuries.

Thus these central bank cash injections in Europe or Japan help to fuel rallies elsewhere, particularly the United States. Most of the time, “elsewhere” also means the stock market. Dealers direct money to where it’s mostly likely to get some love. For them, stock investors are the most eager and ready to give it.

All financial roads ultimately lead to Wall Street. The U.S. markets may be crooked; they may be rigged. But they are still the largest, most transparent (that’s not saying much), and most liquid in the world. The Fed or ECB or BOJ pump money into the system through the same mega investment banks that operate in all markets. That’s why I say “liquidity anywhere is liquidity everywhere.”

So the Fed’s cohorts continue to pump money into the world financial pool. The BOJ has been pumping the dollar equivalent of some $70 billion per month. But in January, the ECB cut its monthly bond purchases from 60 billion to 30 billion. That will hurt. It probably contributed to the weakness we saw in U.S. stocks in early February and in bonds relentlessly since the beginning of the year.

My focus is mostly on the ECB because the flows between Frankfurt, London, and New York are so massive and so important to the performance of U.S. markets. I have demonstrated in past reports the strong correlations between ECB actions, European banking system responses, and U.S. market performance. In fact, the ECB seems as important in some ways as the Fed in driving U.S. securities markets, particularly the U.S. Treasury market. European banks are big investors in Treasuries.

While the ECB has added 3 trillion in assets since restarting QE and beginning NIRP in 2014, European bank deposits have only grown by 1 trillion. Money is disappearing from the European system. Much of that is due to deleveraging. As borrowers of all kinds pay off loans, money is destroyed. That’s bearish for all world markets.

We started to see the effects in the first half of this month. Stocks have gotten a reprieve lately. I think that’s temporary. Bonds have been hammered relentlessly, however. The yield on the 10-year Treasury has risen from 2.40% at the end of 2017, to 2.92% today.

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This month, FCB buying of Treasuries and Agencies has broken out of a nine-month downtrend. FCB buying can partly offset the Fed’s draining operations if it persists. However, it’s too soon to tell if this surge is a one-shot deal or a trend. It’s at least short-term bullish, and we have already seen the effects of the liquidity it pumps into the system in the form of a stock market rally.

FCBs have bought $44 billion in Treasuries on balance over the past four weeks. That buying was more than offset by selling from other types of investors. Bond prices have plunged. Sellers of bonds used the cash to rotate into stocks in the last two weeks.

When the FCBs pull in their horns, those inflows through the stock market will cease and stock prices will plunge again. We need to look out for that because FCB buying is in a range where it usually reverses within weeks. This suggests that the February stock market rally’s days are numbered.

If we hadn’t seen the effects of the ECB’s big reduction of QE purchases in early January, we certainly did in early February as both stock and bond prices plunged. Now we are also beginning to see ECB assets begin to flatten out. The ECB has cut its QE purchases in half to just 30 billion a month. That will barely help in Europe, let alone leave enough left over to send to U.S. markets.

Europeans are voting with their money, and as far as U.S. investment is concerned, that vote is NO! They are selling and redeeming Treasuries and repatriating the dollars they receive from those sales and redemptions. They buy euros with those dollars and bring the money home to Europe. That’s why bond yields are rising and the dollar is falling. That has confused Wall Street pundits, but it doesn’t confuse us. I started talking about this trend soon after the 2016 election.

While recently reducing QE, the BOJ and ECB are still printing money and pumping it into the worldwide cash pool. A weakening dollar has increased the dollar value of the ECB and BOJ QE over the past year. Their euros and yen now buy more U.S. assets per unit of their currency. That had been sufficient to continue to power U.S. stocks higher even with the Fed holding its balance sheet flat since the end of 2014.

I warned repeatedly last summer and fallthat that would change when the Fed began to shrink its balance sheet because it would subtract cash from the worldwide pool in steadily increasing amounts.

The red line on this chart represents the value of central bank money pumped into the worldwide pool of cash. It will begin to flatten. As the Fed drains increasing amounts of money from the U.S. banking system and markets, and the BOJ and ECB continue to reduce and eventually end their QE programs, a grinding bear market in the United States should follow.

The One Dangerous Country You Should Be Watching Right Now

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Lee AdlerLee Adler

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Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.

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