Agency MBS

One of the more vocal economic skeptics (as pertains to the developed world at least, China not so much), CLSA's Chris Wood, chimes in with his latest weekly observations on the economy, which are not for the faint of heart, in the latest edition of GREED and fear. Digging in.

Today the Fed released its Q4 Flow of Funds, aka Z.1, report. Using the data in this report, some have focused on such temperamental measures as household net worth, which in Q4 came out at $54.2 trillion, a $700 billion increase from Q3. What they will not disclose is that all of this increase came courtesy of the stock market, as the "Equity Shares at Market Value" line increased from $15.546 trillion to $16.234 trillion: this represented the entire increase in household net worth. Should the market dive, as many are concerned it is will once the Fed stops manipulating the mortgage (and potentially equity) market, watch all this intangible net worth disappear, as unbooked profits are just that - unbooked. Others will tell you that consumer deleveraging continues unabated, which is true: the decline in total non-financial debt in Q4 for Households and Businesses was -1.2% and -3.2%, respectively. Who made up the difference: the US government of course, whose domestic nonfinancial debt holdings increased by 12.6%. We, instead focus on Tables F.209 and F.210, the detailed listing of holders of US Treasuries and Agencies/MBS securities, as this is precisely where the Fed is the dominant market maker, and the means by which Ben Bernanke continues to manipulate the market by being the perpetual bid for 5% and lower yielding securities, thereby forcing all other yield chasers to go lower in the cap structure and buy, buy, buy all equities. And while there are no major surprises in the data set, it is notable that even as the Fed has purchased over $1.5 trillion in Agency/MBS debt, the total amount of all such securities over the past year has remained constant. The Fed has been buying everything that other have been selling. Adjust the data to exclude the Fed's purchases and one sees just how scary the MBS situation truly is.

Over the weekend we posted a very critical paper by the Minneapolis Fed discussing the potential weakness with the various liquidity extraction mechanisms (in the absence of a Fed Funds rate hike). Today, the Fed goes one step further, after noting increasing pressure by its own members to commence a tightening policy, and has announced the expansion of its reverse repo program with Primary Dealers, by adding additional counterparties.And guess who the first expansion wave focuses on - why Money Market mutual funds of course. Let's just do all we can to drain the money market system asap, shall we.

The fed has completed $169.1 billion of $175 billion in the agency MBS program: there is just 3% of Agency dry powder remaining (no new purchases in the week ending March 3). The Fed has completed $1.22 trillion of its $1.25 trillion MBS debt purchase program, or 98%, through March 3 (including the $10 billion announced today). There is now just $35 billion left in Quantitative Easing capacity.

The Federal Reserve's assets were at $2.27 trillion as of February 25, jumping by $6 billion sequentially. Securities held outright: $1,975 billion (an increase of $62.6 billion MoM, resulting from $59 billion increase in MBS and $3 billion in Agency Debt), or $8 billion increase sequentially. The fed has completed $169.1 billion of $175 billion in the agency MBS program, or a 97% completion, and 96% complete with purchases of Agencies. The Fed has completed $1.21 billion of its $1.25 billion MBS debt purchase program, or 97%, through February 25. There is just $45 billion left in QE. Net borrowings: $103 billion. The monetary base increased by $81 billion in the past fortnight to $2.14 trillion. The ratio of total assets to Monetary Base declined slightly to 1.06x. Float, liquidity swaps, Maiden Lane and other assets: $191 billion. The CPFF program was at $7.7 billion. FX liquidity swaps are now at zero: we are carefully keeping an eye on this metric as any increase presently would indicate banks are again experiencing a dollar funding shortage. Maiden Lane I and Maiden Lane II increased and were $27.2 and $15.5 billion, while Maiden Lane III as always continues pretending it has value and came flat at $22.4 billion.

Since everyone is expecting it, maybe it won't happen?

On the heels of the surprise discount window rate hike late last week, and on the eve of Bernanke’s Congressional testimony, speculation abounds as to the when and where of the next round of tightening. We need look no further than the US Treasury press room, as it has announced today a revival of sorts for its Supplementary Financing Program (SFP).

Goldman's Alec Phillips provides some perspectives on why the recent announcement that the GSEs will purchase 120+ day delinquent loans will not be a major impact to either the overall MBS market or to the Fed's QE tactics when it comes to stabilizing the market. Furthermore, in addition to not being a material mitigant to the Fed's massive balance sheet holdings, some direct implications as pertains to end borrowers include a greater incentive to foreclose, a greater emphasis on non-modification strategies, and more aggressive modification efforts. Yet the major issue, the one addressed by the Fed's Hoenig yesterday when discussing the urgent need to commence selling Fed assets asap, will likely be completely sidestepped, in essence stressing the need to find a legacy replacement through to QE when it expires in just over a month.

What's a difference of a Trillion dollars in Spain's reported External Debt mean? It changes the debate from solvency to liquidity. An important difference.

Cliffnoting the just released Bernanke testimony in praise of the printing presses. Lots of theory, no forward looking calendar. "At some point" in the future liquidity will be tightened. But not yet. Not yet.

Everything that the government has done so far, with a few minor detours, has been almost exclusively focused on maintaining home prices high, by tweaking either the supply or the demand side of the housing equation. As the bulk of consumer net wealth is concentrated in the housing sector, and a wealthy and confident consumer, much more so than the banking system, is critical to the recovery of America's economy, the Administration will do everything in its power to achieve its goal of artificially manipulating the housing market, thereby not causing an incremental loss of wealth to those still stuck with overpriced houses, while the real intersection of actual supply and demand curves would indicate a materially lower equilibrium price. This is ironic, as proper price discovery is critical for a true recovery, since Americans realize all too well that buying a house at prevailing levels in advance of the second down-leg in housing is senseless, the continued pursuit of such flawed policies by the Fed and President Obama merely pulls the market ever further away from its equilibrium, thereby making the anticipated second dip so much more likely and not that far off in the distant future. Below are 5 simple charts the highlight just how precarious the housing situation in the U.S. is, and how likely the second, and probably much more fierce, leg down in the markets is going to be.

A discussion of the cash flows of Agency MBS and what it means to Fed policy. It might be the basis of QE 2.0 Lite. Also a side story on how Big Ben juiced the market in March/April of last year. Just another one of those things that were done to put some money on the 'Street'.

Excess injected marginal dollar liquidity has propped up risk assets (and consequently bank balance sheets) and bank capital bases, both domestically and abroad. 92.5% of the liquidity injected from quantitative easing (version 1.0) has been deployed already, leaving under $125B of remaining injections. With a secular credit downturn as the macro backdrop to these reflationary measures, the USD demand resurgence via deleveraging and debt deflation, as well as the much-needed capital inflows into dollar-denominated debt after a declining dollar and risk aversion has led to 30-yr wide 2s20s, what is the downside risk in all assets besides USD and USD debt?

Economics 101: when supply is greater than demand, prices fall; when supply is $700 billion greater than demand, prices plunge. An in-depth look at the supply-demand mismatch of the 2010 US Treasury market demonstrates that the truth is much worse than you may think, and why Bernanke's first act upon reconfirmation will likely be the announcement of the second part of Quantitative Easing.

The EUR/USD foretold the weak dollar-driven asset rally that characterized the post-dotcom crash 2000s, the inflationary energy bubble/crisis in late 2007 to summer 2008, the liquidity crisis in fall 2008 to spring 2009, and the liquidity rally since spring 2009. Could the strong reversal since December be forecasting a return to mean reversion and a rush to (dollar) liquidity?