Nic Lenoir's Advice What To Do On POMO Days
Submitted by Nic Lenoir of ICAP
I read last year an analysis on trading the S&P 500 on days where the Fed conducts Permanent Open Market Operations (POMO). It basically stated that pretty much the entire rally from March to October was driven by POMO and that the advance of the market on those days was equivalent to the entire advance of the market over that period. It's not the exact conclusion but close enough if I recall correctly.
With the Fed starting to reinvest interest payments on its assets in Treasuries, I decided to dig in and see for myself with the help of my colleague Mike Lawrence. The results are calculated using the 60 occurrences which makes them statistically relevant.
The results are graphically quite easy to interpret, but basically here are my conclusions: For the S&P from March to October the market rallied roughly 0.2% a day, and on POMO days that number is 0.25% (the day before is 0.29%, the day after is 0.15%). That basically tells me that from an S&P point of view there is not much to it. There is definitely a tendency the day of those operations to rally post auction from 11AM into the close (0.12% on average) which is more pronounced than other days, but it should be more a timing consideration to factor into one's trading decisions that a real trading opportunity of its own.
For Fixed Income however the results are significant. The Y axis on the charts in the attached documents is the Chang in price of the 10Y Treasury bond converted in basis points (-3bp corresponds to a sell off of 3bp, or yields higher by 3bps). Apologies if it is counter intuitive that's how my program spit the results out. First of all, coincidence or not, the day before the repurchase the market sold of an average of 1.2bp, compared to 0.5bp being the average from March 2009 to October 2009. But more importantly we see that the 10Y Treasury has a tendency to rally AHEAD of the fed repurchase operations, and post 11AM, the market sells off an average 1.2bps which is between 3 and 4 times the average magnitude. Another point of interest is that the dispersion of hourly moves is significantly greater during that day. It does not seem to be tradeable using the MOVE index, but from an intraday perspective volatility spikes and the market has a clear pattern of rallying into POMO and selling off afterwards.
As much as I would like to have uncovered evidence linking more directly the government's actions to equity price action, the facts do no corroborate. From a fundamental standpoint there is absolutely no doubt that the liquidity injection by central banks and government stimulus was 100% of the recovery both economically and in asset prices, but it is not tradeable on a micro level. The actual US Treasury purchases does provide opportunity and there is no doubt that dealers are cleaning up on this.
Good luck trading,