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Is Massive Primary Dealer Year-End Window Dressing A Key Reason For The Recent Bond Sell Off?

Tyler Durden's picture





 

Ever since Repo 105 (and long before that), it has been well-known that Primary Dealers enjoy padding their books before the end of every quarter, typically collapsing their asset holdings in the week just before the quarter end in order to have cash on the books, and to make their capitalization ratios appear better than they really are. Well, the "book padding" that just occurred in Q4 2010 was a doozy, with total PD asset holdings plunging by a stunning $126 billion in the past month, the bulk of which was due to a drop in PD holdings of Treasurys. Was this huge selling by the Primary Dealer community, either for window dressing reasons, or due to expectations of future increases in Treasury yields, one of the main reasons for the drop in bond prices? It is unclear, but the massive selling certainly has not helped. And now that window dressing is again over for at least three more months, PD holdings can only go up (or so the myth goes). So with PDs now back with fresh books for 2011, and once again lifting offers, is the sell off in bonds about to be replaced with a major buying spree?

Using New York Fed data, we have compiled weekly Primary Dealer holdings for all of 2010 (and going much further back). The window dressing observations are stunning, and shows that regardless of the short-term scandal over Repo 105, banks continue to pursue short-term book padding strategies. And in Q4 the difference from the peak in asset holdings, attained on November 24, when PDs accounted for $368 billion in total asset, to the drop, which as always just so happens was on the last day of the quarter, was a massive $127 billion, to a low of $241 billion.

The chart below shows total Primary Dealer holdings on a weekly basis, with the EOQ/EOY holdings highlighted in red:

The selloff was particularly evident in Treasury holdings, both Bill and Coupon. The chart below, which shows seggregated and total UST holdings by PDs speaks for itself:

From a weekly fund flow perspectve, the sell off was pretty much across the curve:

For those who want tabular detail, here are all the weekly PD holdings across all disclosed asset classes (equities, of course, are those that get goosed the most courtesy of POMO; these however are never disclosed as they are irrelevant for Fedcollateral purposes, until, of course we have another Lehman, and PDs pledge bankrupt stocks at 100 cents on the dollar with Bill Dudley).

What is notable in the chart above is that PDs year end comnbined holding position is only $22 billion higher than its was at the beginning of 2010, mostly due to an increase in MBS ($16 billion) and Coupons ($15 billion). What is troubling is that PDs actually closed 2010 with a $6 billion lower total position in corporate bonds compared to the start of the year. And this occured in a year in which corporate bonds closed at nosebleed levels, and saw tons of buying by hedge funds and retail. At least we now know who was dumping the hot grenades to the greater corporate bond foolds.

But probably the most dramatic chart is the one showing quarterly window dressing, together with quarter minimum and maximum holdings by PDs. That we closed at the lows as now traditional is not surprising. After all there is window dressing to be done. What is more troubling is that the closing Q4 level was the lowest close in all of 2010, and in fact the closing print of $241 billion was last seen back on December 30, 2009, when total holdings were $218 billion (only to increase by $34 billion in the next week).

Bottom line, now that the PD books are clean, look for PDs to start buying up all the bonds that retail and all other greater fools are finally selling after accumulating for one year, as the primary dealers reestablish much lower cost-bases. It also means that PDs will now be a bullish impact on bond prices. We are curious how this will be reconciled with the Fed's endless POMO machine, which demands that PDs flip at least half of their holdings in the Fed's endless quest for monetization.

 


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Mon, 01/10/2011 - 10:08 | Link to Comment dcb
dcb's picture

THE ANSWER TO THIS IS OF COURSE.

i HAVE MADE MENTION OF THIS BEFORE ON THIS SITE. WHY DO YOU THINK THE QE TWO

WAS RAMPED UP THE LAST TWO WEEKS OF DECEMBER. MUCHY OF THE QE IS TO PREVENT THE SELL OFF AND HIDE THE WINDOW DRESSING. IT ALSO PREVENTS THE

PUBLIC FROM SHORTING THE MARKET FOR EASY PROFITS WHILE THE BIG

BOYS WINDOW DRESS. JUST WATCH THE TIMING. i SEE FURTHER ROOM FOR THE HIGHR MARKET BECAUSE THEY CAN UNDO THE WINDOW DRESSING.

Mon, 01/10/2011 - 10:12 | Link to Comment goldmiddelfinger
goldmiddelfinger's picture

Ergo it's time to hit the Bubble Ben's bid on PCLN and buy the Robt Stack/Tim Geith 10y offer.

Mon, 01/10/2011 - 10:13 | Link to Comment Oh regional Indian
Oh regional Indian's picture

While stocks are for scalping Joe and Mary of their "real" (hard to call it that) money, it's clearly Bonds and FX where the big money moves. Both those markets have major players make calls that move markets (Governments, Central Banks and the like). Metals is the biasing factor, but nowhere near big enough (currently) as Bonds and Fx.

if you believe that thesis, then the PDs are only given primary, front row seats because they can follow orders (strict ones) while appearing to be independent actors.

The bigger question then is, when will SDC (Sovereign Debt Crisis) strike Primary Nations. And will the Dollear be the last currency to crash?

Marching to orders is all. If the pattern of padding is so clear, then it is about to reset.

Seems like most everything else is.

ORI

http://aadivaahan.wordpress.com/2010/11/13/wisdom-for-warriors-4/

Mon, 01/10/2011 - 10:16 | Link to Comment What_Me_Worry
What_Me_Worry's picture

Quite a few good auctions going on this week.  Anxious to see what the PDs decide to bid.  10 year really jumped off the bottom.

I figured the PDs inventory would naturally fall, in response to the Fed's massive buying.

Mon, 01/10/2011 - 10:21 | Link to Comment Mike2756
Mike2756's picture

Or was it the belief that things are improving and stocks are the place to be? Maybe the news out of China will change this.

Mon, 01/10/2011 - 10:29 | Link to Comment SITruth
SITruth's picture

It seems to me that Bernanke now wants the PDs to crash the stock market and scare money back into the bond market to drive down interest rates, which may also set up cover for him to justify QE3 and continue the bankster bailouts.

Mon, 01/10/2011 - 10:37 | Link to Comment Cleanclog
Cleanclog's picture

When do you think our PDs will be instructed by the Fed to commence buying Portugese, Spanish, etc bonds.  Will Fed start POMOing them too?

Mon, 01/10/2011 - 10:50 | Link to Comment Oh regional Indian
Oh regional Indian's picture

Maybe next week? It's in the pie for sure, Dollear sucking in all the world's trash paper before crashing itself.

A giant whooshing sound.....

ORI

http://aadivaahan.wordpress.com/2010/11/10/wisdom-for-warriors-2/

Mon, 01/10/2011 - 10:40 | Link to Comment AR
AR's picture

ROBO (this may be of particular interest to you).  In an indirect way, we referred to some of these points and also what we expected once year-end would pass.  We hope some could take advantage of the information at the time.  Good luck everyone.

by AR   /  on Sat, 12/18/2010 - 23:27  /   #816492

ROBO  /  As always, we hope you are well.  The other day we posted the following on Bonds (see below).  Bonds will remain a little sloppy and volatile for the next 2-3 weeks, but can retrace some of the 8-10 day recent sell-off (see levels suggested below). Nimble traders can probably trade BOTH sides of this market during this time pulling out 16-32 ticks. In this period, we would not marry oneself to any particular side however (rather trade the ranges the market gives you).  Good luck our friend, as we always find your posts worthwhile and entertaining.---------------------

by AR   /  on Wed, 12/15/2010 - 15:13
#809157   / 
In BONDS  /  Yesterday (On Tuesday 12/14) we suggested the following:

by AR  /  on Tue, 12/14/2010 - 17:03  / #806134 

We might be a little early, but, we suspect this recent down leg in treasuries is close to a short-term bottom. 30's tested our 119.07 support target area today. Thus, it would not be unusual to see 30's bounce and retest the 124.00/125.00 area testing the staying power of the shorts. We've had a quick 8-9 handle move down in the last 10 days. Therefore, the risk here is overstaying one's shorts. This market will give everyone another sell signal from higher levels. It's prudent to peel back some exposure down here if one hasn't already. Good luck everyone.  -------------------------------------

Today (On Wednesday 12/15), again, we just retested these levels (actually 118.21).  There is a lot of "overhead pressure" on this complex right now (which will abate in the next 2-3 weeks). Much of it comes from the fact that few PM's are in the black in this sector after this recent 10 day meltdown of 8-10 handles. If long positions are initiated, do not be afraid to quickly take profits and trade them aggressively until you see some better stability in price levels. 16-32 ticks per day is not unreasonable trading them with this type vol and in this environment.  Short-term risk is down to 117.27 area if these levels are breached in 30's. We are hearing margin departments are being very aggressive this week as the direction (lower) wasn't a surprise, however, the size of the move in this short time period was. Some too may want to look at the calls for the 123 to 125 strike (February or March expiry). Good luck everyone.  --------------------------------------------

 

Mon, 01/10/2011 - 12:43 | Link to Comment Captain Kink
Captain Kink's picture

I saw the same, but not til last week.  March 125 calls.

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