With FRBNY Brian Sack's Permanent Open Market Operations (POMO) now firmly back on the scene, and by all appearances about to grow orders of magnitude larger than the prevailing $10 billion a week levels following implementation of QE2, we have been bombarded by requests to explain the methodology behind what the 10:15 am - 11:00 am liquidity intervention by the Fed means in terms of asset prices. We recently presented Nic Lenoir's observations on how POMO impacts rates on an intraday basis. However, the most comprehensive report on the issue comes courtesy of Bob English as the Precision Report. His analysis titled A Grand Unified Theory on Market Manipulation is a must read for everyone who dares to trade ahead of the Fed on POMO days (which, incidentally, this week will be on Tuesday and Thursday). While the report is as of August 2009, the logic behind it is as relevant and applicable today as it was when first written.
Here is Bob English' summary on the topic:
There is much speculation and anecdotal information regarding the rally that began March 6 2009, which have suggested the gains are the result of massive manipulation on the part of the Federal Reserve (FR) and the large institutions that dominate Treasury securities dealing, program trading and the derivatives markets. Traders have reported that traditional indicators and metrics used for market analysis stopped working for periods of time or altogether, and that correlations among markets have been erratic and quick to change. Record program trading by Goldman Sachs as reported by the NYSE, heightened focus on high frequency trading (HFT), outsized profits by the large and well-connected banks, along with unprecedented intervention by the FR in the markets only fuel the manipulation speculation.
If we had a big picture model (a Grand Unified Theory, or G.U.T.) that described the intentions, motivations and actions of the influential players, we could attempt to predict future market direction. A limiting factor is that the rules of the game have changed quickly, and what we believe is important to the major players now may not necessarily have been important twelve or even six months ago. Accordingly, while we will present as much supportive data as possible, our sample sizes will be small and we will rely on educated conjecture when necessary. As such, we would expect to be, at worst, self-referentially coherent and, at best, correct in our predictions for the coming weeks and months.
Full report, courtesy of The Precision Report (link)