How The Fed Sourced 83.4% Of Treasury Cash Needs Since The Start Of QE2
It is no secret that since the start of QE2 in November, the US Treasury has issued a gross $890 billion in debt in the form of various Bond, Bill and TIPS. This is cash that the US received in exchange for promises to pay interest and principal at maturity on various series of bonds. At the same time, over the past 5 months, there was $291 billion in debt maturity paydowns, or cash leaving the Treasury and going to those who are lucky enough to receive principal on US debt at maturity. That leaves a net of $589 billion in debt that was issued between November 1 and March 31: money used to fund the ongoing operations of the United States. This is all perfectly public and well-known. After all, every single auction is loudly announced by CNBC at 1 pm Eastern on auction days, with a breakdown between Direct, Indirect and Primary Dealer takedowns. Note that the Fed does not feature in this list of primary issuance bidders as that would be illegal, and would be monetization beyond even any semantic argument that the Fed does not, in fact, monetize. What is less known is that the true action in US Treasurys occurs in the secondary market, or that dominated by the Federal Reserve. Here is where the daily POMO takes place, where as we have noted on many, many, many occasions Primary Dealers promptly flip bonds purchased during a primary auction right back to the Fed. This is where the real source of Treasury funding comes from. And what many may not be aware of is that since the start of QE2, the Federal Reserve has purchased $491 billion of Treasurys in the Open Market (and $556 billion since the start of QE Lite). This $491 billion in indirect monetizations ultimately ended up funding government cash needs. In other words out of $589 billion in net issuance, the Fed has been responsible for 83.4% of the money needed to fund government transfer payments (among many other uses of funds) and keep the US consumer "strong", not to mention funding US defense, education, healthcare and every other aspect of US day to day cash needs. QE2 is supposed to end in precisely three months. During that time the Fed will fund another $400 or so billion in US cash needs. What happens after, nobody knows.
The same story in chart form.
First, we present the official story of who buys Treasurys at auction. This chart shows the monthly take down of all auctions since November, broken down by Primary Dealer, Indirect (foreign) and Direct (everyone else) investors (as well as token non-competitive purchases). Note: no Fed here.
On the chart above note that in March we had the smallest absolute Indirect interest in US Treasurys (a delta filled by the return of the mysterious Direct Bidder).
The next chart shows the same story but broken down by new bond issue maturity. The two bonds sought after the most are 2 and 5 Years, of which $175 billion has been auctioned off each.
Next, we refine the issuance data, by going from gross issuance to net: namely removing contractually require cash outflows in the form of Pay Downs, showing what the true New Net Cash inflow is (black line).
Which brings us to the key chart: the only question remains how much of this net cash need comes from the Fed. The answer: 83.4% of the total cash over the last 5 months. And the only reason this number has declined is due to the increasingly lower amount of MBS that are prepaid to the Fed, resulting in a lower QE Lite component of Treasury funding. What is amusing is that in January the Fed indirectly funded $122.1 billion of total Net cash needs of $113.2 billion, or a 108% overfunding.
And so now everyone knows just who is reponsible for the ongoing funding of the US government. Amusingly, Congress squabbles over a government shutdown due to a $30 billion discrepancy which is the amount the Fed monetizes in one week. A far bigger question for the government's ongoing operation, is just who will step in to provide this 83.4% of ongoing cash needs when the Fed supposedly ends monetizing debt on June 30.
Which incidentally brings us to one tangential point. As Stone McCarthy demonstrates, the average maturity of the Fed's $1.33 trillion in Treasury holdings (and $1.7+ trillion by the time just QE2 is over) has declined consistently since 8 months ago, dropping from over 80 months to just 66.7 months.
We expect by the time QE2 is done that the average maturity of Fed holdings will be under 5 years. In other words, should the Fed go ahead and actually reverse its buying patterns, which means at some point it will be forced to flood the market with Treasurys of increasingly shorter maturity, the UST curve will pancake overnight, as the market panics, discounting such a move by the Fed. This means that the 2s10s will go from 264 bps currently to sub 100 bps, or possibly invert, as the curve of such stalwart countries as Ireland and Portugal is doing recently. This is tantamount to the immediate execution of all financial institutions in the US that rely on borrowing near and lending far (read all of the hedge funds formerly known as banks). So before anyone tells us that the Fed is preparing to tighten, be it by ending monetization, ending ZIRP, or even hiking rates, can they please explain to us just what will prevent the outright second insolvency of the US banking system?