Brian Sack Hints What QE3 Will Look Like, Discloses The Fed Has 200% More Duration Risk Than Normal

Tyler Durden's picture

A few weeks ago we first reported what, according to Bill Gross, the upcoming QE episode may look like: namely a version of Operation Twist from the 60's in which the short-end of the curve -arguably the 2 or 3rd year point- is locked, resulting in a record steep yield curve while allowing ongoing bond monetizations to proceed. While that is a useful frame of reference, a far more relevant observation is what the man in charge of the world's largest bond portfolio -none other than the FRBNY's Brian Sack- has to say about what the future of QE holds, which he conveniently has done in a speech to Money Marketeers today titled, "The SOMA Portfolio at $2.654 Trillion." In addition to the future of the Fed's SOMA, Sack shares some other much needed information such as the trading details of the QE program from the view of the Fed, his perspective on the QE2's strengths and weaknesses, and his overall assessment of the program's effectiveness. Not to mention his admission that the Fed now carries 200% more interest rate risk than it should...

First, for those who lived and died by the daily POMO for 8 months, here is how Sack breaks it down:

Over the life of the program, we conducted 140 outright purchase operations to meet the directive set out by the FOMC. That meant that we were active on nearly every day possible over that period. In those operations, the Desk bought $767 billion of Treasury securities, which included the $600 billion expansion of the portfolio and $167 billion of reinvestments. Our operations ranged in size from just over $1 billion to around $9 billion, with an average size of about $5.5 billion.

Those operations brought the amount of domestic assets held in the SOMA portfolio to $2.654 trillion. The current directive from the FOMC instructs the Desk to continue to reinvest the principal payments on all domestic assets held in SOMA into Treasury securities. Thus, the amount of assets held in the SOMA will remain at that level until the FOMC decides to change the directive.

Of course, the portfolio at these levels is unusually large. In the absence of the asset purchase programs, the size of the SOMA portfolio would be around $1 trillion, as required to meet currency demand and other factors. Thus, the Federal Reserve has about $1.6 trillion of additional assets in the portfolio as a result of its asset purchase programs.

The SOMA portfolio also has different characteristics than it would have had in the absence of the asset purchase programs. Most notably, the overall duration of the SOMA portfolio at the end of June was over 4½ years, compared to its historical range of between two and three years.

For those who are still wondering who the largest holder of marketable US debt is, here it is:

With the completion of the program, the SOMA portfolio
holds about 18 percent of the outstanding stock of Treasury securities
. Our
share of the market is even higher at intermediate maturities, where our purchases
were concentrated.

Next, Sack almost goes into a much-needed discussion of what the Fed's DV01 is at this point, but not quite as that disclosure would confirm just how tremendously precarious for the Fed's capitalization any sustained rise in interest rates would be:

the larger amount and longer tenor of our securities holdings result in a considerable amount of duration risk in the SOMA portfolio, meaning that the market value of the portfolio is sensitive to movements in interest rates. One measure of this risk that is familiar to market participants is the concept of "10-year equivalents," or the amount of 10-year notes that would produce the same degree of overall interest rate risk. At this time, we have about $1.5 trillion of ten-year equivalents in the SOMA portfolio, which is about $1 trillion above the amount that we would have under our traditional portfolio approach. The majority of this additional risk came from the expansion of the balance sheet, but the extension of its average duration also contributed significantly.

Translated: this means that even in the Fed's own view, there is about $1 trillion more in interest rate risk than normal, or about 200% more than normal. Keep in mind Zero Hedge discussed the issue of the Fed's duration risk as long ago as April 2010.

And while we will spare you the Fed's talking points on why QE has been "successful" (for Wall Street and America's corporations yes, for everybody else, resounding no), Sack does share some amusing mea culpas on where he thinks QE has been a failure:

One criticism that has been directed at the LSAP2 program is that it was unable to restore vigorous growth to the economy. I think this is a reasonable observation but not a strong criticism. It is true that the support to growth provided by the asset purchases appears to have been countered by other factors that have continued to weigh on growth. However, the LSAP2 program was never described as such a potent policy tool that it could ensure a return to robust growth and rapid progress toward full employment in all circumstances. [or any]

Despite its limits, the expansion of the balance sheet was seen by the FOMC as the best policy tool available at the time, given the constraint on traditional monetary policy easing from the zero bound on interest rates. The willingness of the FOMC to use this tool is indicative of a central bank that takes its dual mandate seriously and does what it can to deliver on it. The disappointing pace of recovery that has been realized since then suggests that the additional policy accommodation provided by the LSAP2 program was appropriate.

Since when? And on to another counterfactual: re-read the last bolded sentence and tell us if it makes any sense, because it sure does not to us.

Then Sack goes on to describe how in his view the transition from QE2 to a semi-free market has transitioned. We were surprised that we does in fact recognize that since June 30 there has been abnormal vol in the bond market (something we demonstarted earlier) although naturally he does not blame it on the Fed incursion and then withdrawal from the market, but on external factors:

The pace of the Desk's purchases fell back sharply at the end of June, as we moved from expanding the portfolio to simply reinvesting principal payments. In particular, our purchases slowed from an average pace of about $100 billion per month through June to an anticipated pace of about $15 billion per month going forward. We do not expect this adjustment to our purchases to produce significant upward pressure on interest rates or a tightening of broader financial conditions, given our view that the effects of the program arise primarily from the stock of our holdings rather than the flow of our purchases. While there has been considerable volatility in Treasury yields over the past several weeks, we attribute those movements primarily to incoming economic data and to broader risk events.

What precisely would change Brian's perspective on this we wonder: MOVE hitting an all time high in the next week or month? Or will Greece be blamed for that too? Or maybe Bush.

Yet most importantly, and the core topic of this post, is what he says next about what QE3 will look like. To wit:

Given the considerable amount of uncertainty about the course of the economy, market participants have observed that the next policy action by the FOMC could be in either direction. If economic developments lead the FOMC to seek additional policy accommodation, it has several policy options open to it that would involve the SOMA portfolio, as noted by Chairman Bernanke in his testimony last week. One option is to expand the balance sheet further through additional asset purchases, with the just-completed purchase program presenting one possible approach. Another option involves shifting the composition of the SOMA portfolio rather than expanding its size. As noted earlier, a sizable portion of the additional risk that the SOMA portfolio has assumed to date came from a lengthening of its maturity, suggesting that the composition of the portfolio can be used as an important variable for affecting the degree of policy stimulus. Lastly, the Chairman mentioned that the FOMC could give guidance on the likely path of its asset holdings, as the effect on financial conditions presumably depends on the period of time for which the assets are expected to be held.

Alternatively, economic developments could instead lead to a policy change in the direction of normalization. The FOMC minutes released last week provided valuable information on the sequence of steps that might be followed in that case. The minutes indicated that the removal of policy accommodation was expected to begin with a decision to stop reinvesting some or all of the principal payments on assets held in the SOMA. If all asset classes in the SOMA were allowed to run off, the portfolio would decline by about $250 billion per year on average over the first several years.

Try as we might, we don't see the Fed doing much of any normalization considering the miserable failure to offload the Fed's pithy holdings of AIG's Maiden Lane II securities almost broke the RMBS market. But good luck to the Fed.

What is important is that Sack did in fact confirm that the Gross envisioned "Operation Twist" whereby a combination of new purchases and maturity adjustments is most certainly possible. Therefore the only open question is whether he will also be right that Bernanke will announce this expansion during this year's Jackson Hole meeting. Keep in mind the last time the economy was growing as poorly as it is now, and when unemployment had taken another major inflection point higher, it took about 20 days for the Fed to mobilize its LSAP powers.

There is about a month until this year's meeting in Wyoming.

Link to full Brain Sack Speech

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Bay of Pigs's picture

Uh oh....Houston we have a.....

Herd Redirection Committee's picture

Duration risk... Isn't that like when you are scheduled to receive money incrementally over 30 years, but the money is due tp be paid in a lump sum, in 10 years?  And increases in interest rates will result in... Well, its either chaos or pure mayhem, IMO.  Wealth effect evaporates, the market would sell off, all those interest rate derivatives would be triggered, banks and the Fed would actually have to start paying interest...  The Fed's attempts to reduce the money supply would fail because the treasuries and other securities it holds at par could only fetch 65 cents on the dollar...  Am I missing anything?

Check out the latest from the Capital Research Institute "Selling Gold You Don't Have":

"...brings us to the title of this article: Selling gold you don’t have.  The reason for the title?  The CRI is fairly confident that the recent (July 19) bear raid on gold and silver was initiated by massive short selling, by a handful of hedge funds and Wall St banks.  Short selling means selling something you don’t have (or have borrowed) and then buying it back at a lower price.  Now, short selling is not illegal, or something to be feared.  It is a tool, and like any powerful tool it can be destructive if used incorrectly.  Short selling exposes one to unlimited potential losses, and it incurs borrowing costs.  Lastly, you sold to initiate your position, so you have to buy in order to close the trade.  So who ever has bet against gold and silver they have left themselves exposed to unlimited potential losses!  Unlike an equity investment, they can lose more money than the initial amount invested!  And when they close the trade it will push the price of gold and silver back up again! 

Remember when CRI said there are people who will do anything to make you sell your gold and silver?  Yep, yesterday was another one of those days! The key to preserving your wealth in this time of turmoil is to master your emotions, and yesterday was a perfect example of that.   In the time it has taken to write this article the price of silver has risen from $38.55 to over $39.40, retracing most of yesterday’s losses. "


drbill's picture

Calling it QE3 would have bad karma. Let's all try to guess what the next euphemism for money printing will be called.

JustPrintMoreDuh's picture

Spontaneous Currency Accumulation Management

Founders Keeper's picture



How 'bout...







Goldtoothchimp09's picture

Doctor Feelgood's snakeoil v. 3.0     "it will cause what ails you!"

Mr Lennon Hendrix's picture

With a picture of John D. Rockefeller's slithery smile on the bottle.

LibertyIn2010's picture




Kicking &



PrinceDraxx's picture

How about "Steerike Three! You're Outta here!"

TruthInSunshine's picture

Somewhat OT, a little bit ON Topic, but I dedicate this as the Official Song of The Bernank (think metaphorically):

  Weezer - Undone

Back on topic completely; I view all of this 'talk' as so much bullshit, just like the "there will be tanks in the Street/Martial Law if you don't give us a blank check for TARP immediately" so we can bail out the big boys on counterparty risk and their cesspool acquisitions of roach motel assets being spewed forth in 2008 by Hank The Tank Paulson, The Bernank & Timmay Break It Again Jeetner.

Global Hunter's picture

lying on the floor lying on the floor I've come undone...I hope that part is quite literally what is happening rather than a metaphor

TruthInSunshine's picture

If Americans were smart enough to call the bluff, they'd pull The Bernank's string of his sweater, and Obama and Geithner's, too (but especially Bernank's), and they'd see these guys as the Emperors with No Clothes that they truly are, and they'd rejoice.

Just...default. Really.


If most Americans knew even a fraction of truth about what the Fed is and who it serves, they'd be threatening their so called representatives that they're toast if they DON'T refuse to raise the debt ceiling or authorize any additional spending, even at the risk of having defaults and haircuts roll in.

nmewn's picture

"If most Americans knew even a fraction of truth about what the Fed is and who it serves, they'd be threatening their so called representatives that they're toast if they DON'T refuse to raise the debt ceiling or authorize any additional spending, even at the risk of having defaults and haircuts roll in."

Dats a fact.

They bring people up on RICO charges for a lot less.

Yen Cross's picture

  Ya mean those ECB, BIS,IMF things? +1

nmewn's picture

Exactly those things Yen.

They can no longer hide behind the veil of prudent finance with their decimation of popular mediums of exchange or any common good derived from their activities or any pleas to patriotism or any of the other devices used to sooth the populace.

They are simply parasites feeding off the labor of others.

Ricky Bobby's picture

OK peasants you see that mountain over there, well were going to turn it into a great monument to our God King. Of course you will have to chip rocks for 30 years. The priests at the temple say it is God's will, so be it.

gwar5's picture

They're the biggest criminals in world history hiding in plain sight.

slaughterer's picture

Does some genius hedge fund analyst here have the intelligence to predict what effect OpTwist will have on high-beta momo equities and commodities?  (The effect on Treasuries is rather easy to predict).  Please submit your predictions here right now.   

Founders Keeper's picture

[ much bullshit, just like the "there will be tanks in the Street/Martial Law if you don't give us a blank check for TARP..."]---TruthInSunshine

Actually, I think Hank was only slightly exaggerating. Martial Law was indeed a certainty. Just a surely as it will be a certainty again.

As for the bail-out programs, they were an historic heist. Bankers laughed all the way home. They're still laughing.


bob_dabolina's picture

They took a SOMA in Jacksons Hole and ended up with a twisted Sack

That's what I got out of it

buzzsaw99's picture

The bankers have been jamming it in Jackson's hole for a long time.

bob_dabolina's picture

I live in the Marriner Eccles Building on 20th St and Constitution Ave. My name is Ben Bernanke. I'm 57 years old. I believe in taking care of myself and a balanced diet and rigorous exercise routine. In the morning if my face is a little puffy I'll put on an ice pack while doing stomach crunches. I can do 1000 now. After I remove the ice pack I use a deep pore cleanser lotion. In the shower I use a water activated gel cleanser, then a honey almond body scrub, and on the face an exfoliating gel scrub. Then I apply an herb-mint facial mask which I leave on for 10 minutes while I prepare the rest of my routine. I always use an after shave lotion with little or no alcohol, because alcohol dries your face out and makes you look older. Then moisturizer, then an anti-aging eye balm followed by a final moisturizing protective lotion. There is an idea of a Ben Bernanke. Some kind of abstraction. But there is no real me. Only an entity. Something illusory. And though I can hide my cold gaze, and you can shake my hand and feel flesh gripping yours, and maybe you can even sense our lifestyles are probably comparable, I simply am not there 


AUD's picture

American Psycho?

I read almost the entire thing. There were a few bits I had to skip.

slaughterer's picture

Sack prefers the financial chain saws located in his trading desk to murder grandmas and grandpas. 

slaughterer's picture

Either "American Psycho" or "A Scanner Darkly"

SolidSnake961's picture

Jackson Hole Day should be a national holiday to celebrate a new QE of an era of temp. fake economic growth beginning and one ending

Mr Lennon Hendrix's picture

A toast......

[raises glass] ignorance.

Bay of Pigs's picture

Mr Jimi, what's your handle over there at Turd's?

You are posting aren't you?

Hedgetard55's picture

That sentence had my head spinning also. I guess he is saying that things would have been even worse w/o QE2?

Sack= Just another soldier ant for the Queen.

ChanceIs's picture

SOMA???  Isn't that what people in Huxley's "Brave New World" took instead of alcohol in order to dull the senses and be better able to ingore reality?  As I recall, there was no hangover.  They also decided that there needed to be certain numbers of brain surgeons, and certain numbers of trash collectors.  They adjusted the amount of oxygen available to the in-vitro fetuses so that their intelligence would be shaped accordingly.  Not so much oygen for the future trash collectors and even less for the soon to be Sectretarys of Treasury.

ebworthen's picture


I thought the reference to" SOMA was a joke.

Then I followed the link and found out it is:

"System Open Market Account (SOMA) portfolio"

You can't make this shit up.

I think they are rubbing it in our face.

slaughterer's picture

"soma" Derived from Gr. body. 

For US TV viewers of the 1960s: Cultural reference. "We are of the body" (Star Trek episode #?? on Landru, the outer-space cult).  Nice catch on the Huxley reference.  They must be laughing their a$$es off at the NY fed at putting this over on the American populace.  The greatest monetary joker club of history. 

kaiserhoff's picture

For many moons, some of us have been speculating about what will finally destroy the great ponzi.  The simplest explanation is usually the truth.

Ultimately, governments world wide desperately need inflation to reduce their crushing debt load.

The first whiff of inflation elevates short rates, resulting in an inverted yield curve and the death of all money changers, especially the Fed.

               Shit, meet fan;)

km4's picture

Meadows: Drop your socks and grab your cocks, we're going to a party. 
Buddusky: If this kid gets pussy out of this, I'll eat my fucking flat hat, man. 

The Last Detail (1973)

ziggy59's picture

More of TFFVP. this is the Fuckin Fed Viagra Program. Stays up even though it beee,

caerus's picture

A month is just about enough time for the ES to finish that right shoulder...

slaughterer's picture

When funds get tired of the "blow out earnings" (on lowered consensus expectations) shell game, and enough people are trapped in the post-earnings decline (see AAPL), then it is time for the right shoulder to be finished.   

ThroxxOfVron's picture

No mention of the FED's off balance sheet shenanigans; -such as the duration, notational amounts, and conditionality of the Swaptions that have been rumored to have been sold...

...& about those ML2 'Assets': when are those going to finally be divested ( a cold wind silently blows... ); and did the sales that were completed give Brian 'Ball' Sack any indication of what the M2M for those assets really are?

TruthInSunshine's picture

Maximus: Five thousand of my men are out there in the freezing mud. Three thousand of them are bloodied and cleaved. Two thousand will never leave this place. I will not believe that they fought and died for nothing.
Marcus Aurelius: And what would you believe?
Maximus: They fought for you and for Rome.
Marcus Aurelius: And what is Rome, Maximus?
Maximus: I've seen much of the rest of the world. It is brutal and cruel and dark, Rome is the light.
Marcus Aurelius: Yet you have never been there. You have not seen what it has become. I am dying, Maximus. When a man sees his end... he wants to know there was some purpose to his life. How will the world speak my name in years to come? Will I be known as the philosopher? The warrior? The tyrant...? Or will I be the emperor who gave Rome back her true self? There was once a dream that was Rome. You could only whisper it. Anything more than a whisper and it would vanish... it was so fragile. And I fear that it will not survive the winter.



Gracchus: Fear and wonder, a powerful combination.
Falco: You really think people are going to be seduced by that?
Gracchus: I think he knows what Rome is. Rome is the mob. Conjure magic for them and they'll be distracted. Take away their freedom and still they'll roar. The beating heart of Rome is not the marble of the senate, it's the sand of the coliseum. He'll bring them death - and they will love him for it.


Mr Lennon Hendrix's picture

Who runs this motha?

"Girls...we run this motha....yeah!  Girls!  Who run the world?  Girls!"

BS and Timmah sang and danced along to the tune while clinking glasses in celebration of buying up every asset, toxic and otherwise, in the known universe, before a variable collapse secured their status as BUYER OF LAST RESORT.

"Tuwn it up eye wub dith thong!"  Yelled Bawknee as he plopped himself on the love seat adjacent to Timmah's 8 bit Nintendo they used to run their PPT simulator.

"Girls!  Who run this motha!  Girls!  Who run this motha!"

There was no stopping them.  They had DC by the balls and Walled Street by the ears.  They were gods among grasshoppers.  Lords among field mice.

"Friday!"  Screamed BS over the music.  "Friday it all comes down.  Friday we own everything and nothing at the same time!"

"Weee!"  Giggled Timmah.  "TIMMAH!"

Bawknee waved his pointer fingers in the air with jubilation.  He was so happy he could be accepted by the great Alchemists of the Treaserve.

Girls....Who run this motha.....

Bay of Pigs's picture

Not hearing much about the doelarr lately. 74 and change? WTF?

Anyone seen Bob Rubin around?

Mr Lennon Hendrix's picture


I think that the main reason that the debt ceiling debate was juggled was to prop the doelarr.  If they had just raised the, I mean debt, then the doelarr would have fallen then.  Instead, they juggled and the dollar capitulated.  There might be a last gap but the doelarr is about to die.  Long live the doelarr!

sabra1's picture
  1. China HSBC flash PMI falls to 48.9 from June 50.1
Goldtoothchimp09's picture

For those of you who haven't already viewed  Keynes vs. Hayek -- round 2!!

gwar5's picture

Baby needs new shoes......  Operation Twist, Bitchez!

Thanks Tyler, ZHers will be among the first to know. 


centerline's picture

Someone correct me if I wrong, but wouldn't this be the perfect set up for foreign holdings to take the exits and pushing domestic funds in?  A perfect trap for dumb/desperate money such as municipal retirement funds?