Agency MBS

Up until today, the narrative was one trying to explain how a soaring dollar was bullish for stocks. Until moments ago, when Bill Dudley spoke and managed to send not only the dollar lower, but the Dow Jones to a new high of 15,400 with the following soundbites.

• DUDLEY: FED MAY NEED TO RETHINK BALANCE SHEET PATH, COMPOSITION
• DUDLEY SAYS FISCAL DRAG TO U.S. ECONOMY IS `SIGNIFICANT'
• DUDLEY: FED MAY AVOID SELLING MBS IN EARLY STAGE OF EXIT
• DUDLEY: IMPORTANT TO SEE HOW WELL ECONOMY WEATHERS FISCAL DRAG
• DUDLEY SAYS HE CAN'T BE SURE IF NEXT QE MOVE WILL BE UP OR DOWN

And the punchline:

• DUDLEY SEES RISK INVESTORS COULD OVER-REACT TO 'NORMALIZATION'

Translated: the Fed will never do anything that could send stocks lower - like end QE - ever again, but for those confused here is a simpler translation: Moar.

The day Lehman failed saw the launch of the most epic central bank intervention in history with the Fed guaranteeing and funding trillions worth of suddenly underwater capital. However, what Bernanke realized quickly, is that the "emergency, temporary" loans and backstops that made up the alphabet soup universe of rescue operations had one major flaw: they were "temporary" and "emergency", and as long as they remained it would be impossible to even attempt pretending that the economy was normalizing, and thus selling the illusion of recovery so needed for a "virtuous cycle" to reappear. Which is why on November 25, 2008, Bernanke announced something that he had only hinted at three months prior at that year's Jackson Hole conference: a plan to monetize $100 billion in GSE obligations and some $500 billion in Agency MBS "over several quarters." This was the beginning of what is now known as quantitative easing: a program which as we have shown bypasses the traditional fractional reserve banking monetary mechanism, and instead provides commercial banks with risk-asset buying power in the form of infinitely fungible reserves... So how does all this look on paper? We have compiled the data: of the 1519 total days since that fateful Tuesday in November 2008, the Fed has intervened in the stock market for a grand total of 1230 days, or a whopping 81% of the time!

While some were concerned at the Fed's new quantitative targets as suggesting early tightening, it appears (from the FOMC Minutes) that those fears were somewhat warranted (with most seeing QE ending in 2013):

• *FED SAYS A FEW ON FOMC WANTED QE UNTIL ABOUT THE END OF 2013
• *FED: SEVERAL ON FOMC BACKED QE HALT OR CUT WELL BEFORE 2013 END
• *ALMOST ALL FOMC MEMBERS SAW POTENTIAL QE COSTS AS INCREASING

The punchline: "several" means more than just QE4 hater Jeff Lacker are turning hawkish. Though, even with the risks, they want moar. Pre-FOMC Minutes: ES 1460, 10Y 1.86%, EUR 1.3108, Gold $1674. Post: ES -6pts, 10Y +5bps, EUR -40 pips, Gold -$10.

There was a time when it was nothing short of economic blasphemy and statist apostasy to suggest three things: i) that the Fed's canonic approach to monetary policy, in which Stock not Flow was dominant, is wrong (as we alleged, among many other places, here); ii) that the Fed is monetizing the deficit, thus enabling politicians to conceive any idiotic fiscal policy: the Fed will always fund it no matter how ludicrous, converting the Fed effectively into a political power and destroying any myth of its "independence" (as we alleged, among many other places, most recently here in direct refutation of Bernanke's sworn testimony); and iii) that by overfunding bank reserves, the same banks are left with one simple trade - to frontrum the Fed in its monetization of the long-end, in the process destroying the bond curve's relevance as an inflationary discounting signal, with more QE, leading to tighter 10s, flatter 10s30s, even as the propensity for runaway inflation down the road soars, in the process eliminating any need for the massively overhyped, and much needed to rekindle animal spirits "rotation out of bonds and into stocks" trade (as we explained, first, here). Well, that time is now officially over, with that stalwart of statist thinking, JPMorgan, adopting all of the above contrarian views as its own, and admitting that once again, the Fed and conventional wisdom was wrong, and fringe bloggers were right all along.

The week's most anticipated speech (given Obama's absence from DC) is here. Bernanke's Economic Club of New York extravaganza - where he has previously hinted at new or further policy - is upon us. Sure enough, it's a smorgasbord of we'll do whatever-it-takes (but won't bailout Congress) easing-to-infinity, housing's recovering but we want moar, simply re-iterating his comments from last week...

• *BERNANKE SAYS FISCAL CLIFF WOULD POSE `SUBSTANTIAL THREAT'
• *BERNANKE SAYS CONGRESS, WHITE HOUSE NEED TO AVERT FISCAL CLIFF
• *BERNANKE SAYS FED TO ENSURE RECOVERY IS SECURE BEFORE RATE RISE
• *BERNANKE SAYS HOUSING RECOVERY `LIKELY TO REMAIN MODERATE'
• *BERNANKE SAYS CRISIS REDUCED ECONOMY'S POTENTIAL GROWTH RATE

However, as we have noted previously, once you've gone QE-Eternity, you never go back... and we would this is the 3rd time in a row that someone from the Fed has spoken and stocks have sold off.

Perhaps those sage English philosophers 'The Vapors' were on to something 32 years ago when they asked if we were "Turning Japanese" for it seems the following charts from Nomura certainly suggest the US bond market is heading in that direction. From demographics to monetary policy; from investor allocations to flows; and from bond bubbles and volatility to long-term interest-rate paths, it seems we share a lot more than a love for sushi and pachinko with our neigbours across the ocean as we seem to be chasing after many Japanese models (of asset allocation and macro-economics).

Wall Street is doing some wild and wacky things. UBS has just launched a 16-times-leveraged MBS ETN. The ETN, called the ETRACS Monthly Pay 2x Leveraged Mortgage REIT, offers double the return of the Market Vectors Global Mortgage REITs Index – itself an investment vehicle 8x leveraged to mortgage-backed securities. The idea appears to be that with the Fed acting as a buyer-of-last-resort that prices will take a smooth upward trajectory and that 16:1 leverage makes sense for retail investors as a bet on a sure thing.

Dimon: "So, we were asked to buy Bear Stearns.  Some said the Fed did us a favor...No, no, we did them a favor.  Let's get this one exactly right.  We were asked to do it."

Liar, Liar, Fed-Stoked Bubble Assets on Fire!!!!

These days every pundit and his barber are suddenly central banking gurus and monetary transmission mechanism experts, but while some of them may have an educated guess as to the reality of the matters at hand, none can envisage that which the Fed is able to.  What is almost never considered by most wanna-bees  is that no one in the world has access to as many economic and financial data sets, metrics, and indicators, and the synthesis thereof, as the United States Federal Reserve.  Ben may make mistakes, but he is no fool.  When he acts, he either sees present reason to do so, or he is bracing for a future shock. It is just a matter of time before markets lose complete faith in the recklessness of central planning Ponzi artists.

With their recently announced additional bond purchase programs, both the Fed and the ECB have added a new chapter to their respective handbooks. While at first glance they are both simply the end-game of money-printing-monkeys, Morgan Stanley sees some similarities but more differences that are critical to understand when judging the awesomeness (or not) of these actions. The ECB’s Outright Monetary Transactions (OMT), in contrast to the previous SMP program, will be ex ante unlimited in size but conditional upon government action. Likewise, the Fed’s additional purchases of agency MBS are ex ante unlimited in size (the monthly pace will be US$40 billion but the program is open-ended) and conditional (though not upon government action but labor market performance). Another parallel is that there was only one dissenting member each in the two policy committees (Jeffrey M. Lacker and Jens Weidmann). However, this is where the similarities end. Looking at the details, the two programs actually differ in five important respects.

What the Fed did was actually much more than QE3. Call it QE3-plus... a gift that will now keep on giving. The new normal of bad news being good news is now going to be more fully entrenched for the market and 'housing data' (the most trustworthy of data) - clearly the Fed's preferred transmission mechanism - is now front-and-center in driving volatility. I don't think this latest Fed action does anything more for the economy than the previous rounds did. It's just an added reminder of how screwed up the economy really is and that the U.S. is much closer to resembling Japan of the past two decades than is generally recognized. It would seem as though the Fed's macro models have a massive coefficient for the 'wealth effect' factor. The wealth effect may well stimulate economic activity at the bottom of an inventory or a normal business cycle. But this factor is really irrelevant at the trough of a balance sheet/delivering recession. The economy is suffering from a shortage of aggregate demand. Full stop. It just perpetuates the inequality that is building up in the country, and while this is not a headline maker, it is a real long term risk for the health of the country, from a social stability perspective as well.

So where does this leave us? Well, it’s highly unlikely the Fed will actually implement anything major this week. What we could see is a large, but hollow promise for action, much like the ECB’s promise of “unlimited” bond purchases based on certain “conditions” being met (an empty promise if ever there was one).

The headlines proclaimed - confidence is back and the money-market funds are buying European debt again. This makes perfect sense, Europe is fixed and they are backing up the Corzine truck!! Well, no! According to the report from JPMorgan, Prime MMF assets rose $16bn but the bulk was in secured exposure to German and French banks - not exactly the kind of risk-on short-end exuberance that investors are supposed to infer from the headlines. Just as we have seen everywhere, collateral is king and secured credit is the preferred way - even if it comes at a premium. It seems that while the tail-risk is supposedly gone, even short-duration funds are not comfortable with the conditionality. Isn't it odd how headlines (from Reuters: U.S. money funds add euro zone debt in August) can be so different from reality?