Whispers Of The Inevitable Unwind Of The Fed's SFP Program And The Ensuing $200 Billion Liquidity Injection Commence
It was less than 24 hours ago when we first suggested that the Fed's Supplementary Financing Program is about to end. In addition to providing a $200 billion debt ceiling buffer (which the government will fill up in about a month), we noted that the end of this program, which was previously introduced to gradually phase out the ridiculous (in Q1 2010) amounts of liquidity, would provide an additional $200 billion in excess liquidity over a two month period, or effectively doubling the impact of POMO, which monetizes roughly $110 billion in bonds per month. Specifically, we said: "We are confident the US Treasury will announce that beginning with the
week of February 14, it will no longer roll maturing 56-Day Cash
Management Bills, which means that for the ensuing 8 weeks, one on every
single Thursday, there will be a total of $200 billion in incremental
liquidity flooding the market, and probably sending stocks, commodities,
and everything else that is not nailed down into the stratosphere all
over again." Today, Bloomberg has a full story on just this topic, which discusses precisely the end of the program. It is safe to say that within 2-3 weeks, the SFP unwind will commence, and the market will price in another $200 billion in additional free liquidity, which in turn will lead to excess bank reserves surging to about $1.7 trillion in the next 4 months, 70% higher from where they are now. If you think the market is worried about inflation now, wait until June. And that excludes that virtually certain QE2+ announcement: there is no way that the Indirects can shoulder the burden of buying $3-4 trillion in US Treasuries over the next 2 years. The Fed will have no choice but to continue monetizing everything.
The Treasury Department will probably reduce its borrowing on behalf of the Federal Reserve as the Obama administration and Congress battle over raising the U.S. debt limit, according to Wrightson ICAP LLC.
Treasury officials may shrink the Supplementary Financing Program, currently at $200 billion, to as little as $5 billion while the government’s debt approaches its $14.29 trillion threshold, said Lou Crandall, chief economist at Wrightson, a Jersey City, New Jersey-based research firm that specializes in U.S. government finance. Treasury Secretary Timothy F. Geithner said Jan. 6 that lawmakers must raise the federal borrowing ceiling in the first quarter or risk a default on U.S. debt and a loss of access to credit markets.
When the Treasury sells bills at the Fed’s behest through the SFP, it drains reserves from the banking system and makes the central bank’s job of controlling interest rates easier. The Fed said a year ago that the program, set up in 2008 during the midst of its efforts to prop up the financial system, is helpful to the central bank’s monetary policy goals and might be part of future efforts to withdraw economic stimulus. Treasury estimates the legal limit could be reached between March 31 and May 16.
“Time is running out on the SFP auctions, but there is little risk that the Treasury will terminate them without any advance warning,” Crandall said in a telephone interview. “If the debt ceiling drags on to the point where the Treasury must take more drastic steps to stay under the limit, it might eliminate the SFP altogether.”
So when is the advance warning coming? All signs post to next Wednesday:
The Treasury will provide a borrowing strategy update on Feb. 2, when it announces the amount of securities it will sell under what’s become known as its quarterly refunding. The SFP program is not listed as a topic on the official agenda for the Jan. 28 meeting of the Fed’s 18 primary dealers that takes place before the release of the policy statement.
For now the Treasury is keeping mum on the fate of SFP. Which probably means that one can frontrun the massive inflow of capital about to be unleashed.
Colleen Murray, a Treasury spokeswoman in Washington, declined to comment on plans for the SFP. In a Jan. 21 comment on the Treasury’s website, Deputy Secretary Neal Wolin called on Congress to raise the limit and said proposals to “prioritize” debt payments over other obligations would be “unworkable.”
Yet the core pretext for the unwind of the SFP unwind, extending the debt ceiling, is a joke. At best, it can prolong the agony by a few weeks:
The U.S. can’t avoid reaching the debt limit by reducing the budget as being proposed by some lawmakers, Geithner said. “The need to increase the debt limit would be delayed by no more than two weeks,” Geithner said in his Jan. 6 letter to Speaker of the House John Boehner, Senate Majority Leader Harry Reid and all other members of Congress.
The Treasury chief also said his department’s toolkit of emergency measures, such as tapping government retirement funds and suspending some types of intergovernmental lending, would delay a debt ceiling breach “by several weeks.” At that point, he said, “no remaining legal and prudent measures” would be available and the U.S. would start to default.
Which of course means that as we have long speculated, the only reason for the SFP end is to ramp the market even higher, and to provide it with an even higher drop off point for whatever "unknown" event the Fed has in store in order to unleash QE3, 4, and so forth.
Treasury would likely shrink the SFP before the limit is
reached, according to Barclays Plc and Deutsche Bank AG. The
Treasury has shrunk the SFP in two previous debt-limit standoffs
and then brought it back when Congress restored borrowing room.
We stand by our conviction that the last 56-Day CMB auction will take place in mid-February.
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