Agency MBS

Goldman Explains Why The "Orphaned" 30 Year Will Soon See Buying Interest, Expects A Drop In The 10s30s Back To 110bps

FUG (as Goldman's Francesco U. Garzarelli signs his emails) has released another note with his outlook for the Treasury curve over the next several months. As readers will recall, it was Goldman's call that the long-end would be bought up by the Fed, leading to an implicit flattening of the curve. Nonetheless, the New York Fed disclosed that, as Morgan Stanley expected, the bulk of purchases would occur around the belly, resulting in, as we highlighted yesterday, what turned out to be a record steepening of the 5s-30s, which could merely be the last trump card the Fed has to generate some profitability for the banks, whose core business model, now that the hedge fund and sales and trading model is in shambles with plunging market participation, is the treasury curve trade (long near, short far). Despite Brian Sack's attempt at giving taxpayer capital to banks in this last attempt to goose the banking sector, Goldman continues to be skeptical about further steepening of the curve: "Our best guess (corroborated by our GS Curve estimates) the slope between 10-yr and 30-yr will retrace to around 110-125bp, from 160bp currently." The explanation for why the Fed would ignore purchases of the long bond even as it bids up everything else is as follows: "While arguably increasing transparency and predictability, the Fed has also lost degrees of freedom, and the costs and benefits are yet to be seen. In the eyes of many, the long bond now appears to have been orphaned by the Fed. One explanation for this may be that the FOMC wanted to have some quantification of the potential costs of the asset purchase policy under future interest rate scenarios before its launch." Well, it now knows. And now that the UST curve look literally like a hockeystock, and the Fed is about to be accused of massive telegraphing of intentions by Ron Paul, we expect that Goldman will be proven right as the yield chase game continues, and the Fed ultimately makes it clear that it will have no choice but to gobble up the long-end as well, especially since if as we expect, MBS repurchases will be far higher than expected, resulting in a far greater contribution to monetization due to QE Lite, and leaving far less available for purchase across the balance of the curve.

Federal Reserve Balance Sheet Update: Week Of October 27: A Look At Fed Asset Durations

As of October 27, the Fed's balance sheet was $2.3 trillion, of which the $837 billion in Treasury debt is of course a fresh all time record, soon to be eclipsed by the tens of billions added weekly as per QE2. There is roughly $13 billion left under the current POMO program ending in the second week of November, which by then will be supplemented by a new and improved almost daily POMO. In the past week, bank excess reserves increased by $16 billion after declining by $34 billion the week prior: total reserves stood at $1,008 billion, up from $993 billion the week before. And once again foreign holdings of agency/MBS debt dropped to a new 3 year low, dumping over $100 billion agencies in the Fed's custodial account over the past two months. Last, we take a look at the one topic that will soon be the most talked about subject by every pundit in the econosphere: the duration distribution of Fed holdings.

Federal Reserve Balance Sheet Update: Week Of October 20; Foreign MBS Holdings Drop To 3 Year Low

As of October 20, the Fed's balance sheet was $2.3 trillion, of which the $832 billion in Treasury debt was a new all time record. As per the revised TIC data, Japan's latest holdings of $837 billion are about to be trampled by Brian Sack once again. More importantly, in the past week, bank excess reserves declined by $34 billion: total reserves stood at $993 billion, down from $1.026 trillion the week before. This was in addition to the Fed's $11 billion in POMO excess liquidity. Probably most importantly, foreign holdings of agency/MBS debt dropped to a 3 year low, dumping $100 billion agencies in the Fed's custodial account over the past two months.

Fed Posts Schedule Of Upcoming $32 Billion In POMOs , As It Withdraws Token $260 Million In Liquidity Via Tri-Party Reverse Repo Test

Today, the Fed withdrew a whopping $260 million in liquidity from the market via a Treasury-backed 5 day reverse repo at a 0.20% stop out rate, which is pretty much what banks earn on their excess reserves confirming that this operation was nothing but a travesty. Much more importantly, minutes ago the Fed announced the POMO schedule for the next month: there are 9 liquidity drowning events coming up in the next month. Expect another $32 billion in AMZN, NFLX and AAPL purchasing power to appear magically out of Brian Sack's left pocket. As is now common knowledge shorting on any day, but especially on these days, is suicide. Which is why all natural shorters will continue piling into gold which has become the only way to formally oppose the Fed. Instead of looking at POMO days as stock melt up days, consider them days in which gold will soar even more (due to the recently discussed higher gold melt up beta compared to risk). Trade accordingly.

Sack Sells... Just Kidding - The VP Of The FRBNY's Markets Group Says More, More, More QE Will Actually Do Miracles For The Economy

Brian Sack, head of the Fed's Open Market Manipulation and Intervention Group, speaks. In a presentation he has given in Newport Beach, presumably so that he is close enough to Bill Gross so that Pimco does not even need to leave a trace in calling up the FRBNY, he tells those who care to buy, buy, buy. Well, that's reading between the lines. What he says on the surface is that asset purchasing is an "imperfect policy tool", and yes, he should know - especially as pertain to Amazon and Netflix. He follows by stating that any Fed asset purchase plan should be flexible, while warning that it is difficult to "calibrate" cost, benefit of Fed purchases. Of course, according to him more asset purchases are "unlikely to complicate Fed's exit" - any why would they: there will be no exit at $2.5 trillion, who is idiotic enough to think the Fed will be able to exit at $4, $40 or infinity... Lastly, in a bid to avoid the unemployment line, Sacks says that asset purchases seem to improve financial conditions, and that the economy is "vulnerable to downside surprises." Luckily, as the WGC pointed out earlier, buying gold is the perfect hedge to protect against more Bryan Sack fat finger-type events.

In my view, the evidence suggests that the expansion of the securities portfolio to date has helped to foster more accommodative financial conditions, and further expansion would likely provide additional accommodation. Of course, whether the FOMC decides to take such a step will be determined by its assessment of whether the benefits of additional policy stimulus outweigh the perceived costs of expanding the balance sheet.

FRBNY's Bill Dudley: "I Conclude That Further Action Is Likely To Be Warranted"

Former Goldman chief economist and current FRBNY and PPT President Bill Dudley has guaranteed QE2: "I conclude that further action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident that we will see better outcomes for both employment and inflation before too long." Dudley's remarks demonstrate the wide opinion rift at the Fed, where those who don't feel like crucifying the dollar (Kocherlakota, Hoenig, Plosser) are directly faced with such middle class monsters as Dudley and the Doves (which does have a rockband like quality to it). Nobody should have any doubt as to which side will ultimately win this argument...

Jan Hatzius Q&A On QE2

From Tungstenman Sachs: "Our view remains that the Federal Open Market Committee (FOMC) will once again ease monetary policy via unconventional measures in late 2010 or early 2011. Our views have not changed, and today’s comment discusses them in Q&A form. We believe that purchases of US Treasury securities cumulating to $1 trillion or more are the most likely cornerstone of the program; that the September 21 FOMC meeting is probably too early for a big announcement, but that November 2-3 is a possibility; and that it would likely “work” to a limited degree, perhaps boosting real GDP growth by a little under ½ percentage point per $1 trillion in purchases."

Bernanke Speech Summary: Concerned About Inflationary Response To Additional Monetization

I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions. However, the expected benefits of additional stimulus from further expanding the Fed’s balance sheet would have to be weighed against potential risks and costs. One risk of further balance sheet expansion arises from the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions. In particular, the impact of securities purchases may depend to some extent on the state of financial markets and the economy; for example, such purchases seem likely to have their largest effects during periods of economic and financial stress, when markets are less liquid and term premiums are unusually high. The possibility that securities purchases would be most effective at times when they are most needed can be viewed as a positive feature of this tool. However, uncertainty about the quantitative effect of securities purchases increases the difficulty of calibrating and communicating policy responses. Another concern associated with additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed’s ability to execute a smooth exit from its accommodative policies at the appropriate time. Even if unjustified, such a reduction in confidence might lead to an undesired increase in inflation expectations. - Chairman Shalom

Bernanke Central Planning LLC's First Faux Pas - Contrary To Prior Disclosure, Fed Announces Will Also Purchase 30 Year Bonds

Will someone who read the official Fed statement yesterday, please indicate where it said Liberty 33 would purchase 30 Year bonds? We will spare you the trouble - it was mentioned exactly nowhere. Which is why it comes as a major surprise (and a major loss of P&L to traders who have the misfortune of trading rates), that in the just released schedule by the New York Fed, the Fed has announced it would also purchase 2040 maturities on August 26 and 30 - yes, that would be the very long end. Gotta love the great coordinate and communication between the various branches of the Fed. And yes, this is what happens when you have central planning.

Liberty 33 To Get Busy (Officially) On August 17 When It Will Begin Purchases Of 2 Thorugh 10 Year Treasurys

"The most recent H.4.1 data release indicates that outright holdings of domestic securities in the System Open Market Account (SOMA) totaled $2.054 trillion as of August 4, 2010. The [Liberty 33] Desk will seek to maintain the face value of outright holdings of domestic securities in the SOMA at approximately this level. Due to differences in settlement dates for purchases and principal payments, it is anticipated that the actual level of domestic securities held will vary around this level to some degree.The Desk expects to begin purchasing Treasury securities under this policy on or around August 17. The Desk will concentrate its purchases in the 2- to 10-year sector of the nominal Treasury curve, although purchases will occur across the nominal Treasury coupon and TIPS yield curves. The Desk will typically refrain from purchasing securities for which there is heightened demand or of which the SOMA already holds large concentrations." New York Fed

The Contrarian Market And The Liquidity Glut Dissected

BofA's credit strategist Jeffrey Rosenberg has shared some interesting insights with his clients. In a letter from August 2, Rosenberg explains everything one needs to know why the stock market continues to rise in the face of increasing adversity and ever more negative news:

“I can’t think of a reason to be I guess that is the reason to be bullish.” That quote from a client at our June 30th credit roundtable dinner in our view best summarized investor sentiment at the beginning of July. It also highlighted a key technical reason to have been bullish in July as negative investor sentiment reached a peak at the beginning of the month."

Couple that with the sudden buzz that QE X.X is imminent, and a surge in market liquidity, and once can see how the market is now completely disconnected from fund flows, as contrarian animal spirits, and a rising liquidity tide have once again become the dominant, and only, factors in market tactics, if not strategy. And speaking of liquidity, here is an analysis of the key source and uses of liquidity in the market currently.