Open Market Operations

A topic which we anticipated last summer, and which has come to shocking and rapid fruition ever since the beginning of the year with the self-immolation of a Tunisian protester, resulting in a tsunami of violent revolutionary uprisings across the developing world, has been the question of whether and to what degree Bernanke's monetary policies are responsible for what is becoming an indirect wave of suppressionary genocide (today alone, between Libya, Yemen and Bahrain over 500 people have been killed). And while Zero Hedge is far less ambivalent about the underlying cause of the surge in anger (in most of the affected countries, the bulk of their population has to spend well over half of its income on food and energy), and when people who already have nothing, see whatever little they have left taken away as well, they see no downside in violent revolution, there are some more moderate views. Below we present one, courtesy of reader Chindit13.

One would think that the S&P doubling from the March 2009 lows would be indicative of a mission accomplished for the Fed's market manipulation, aka Open Market Operations, team. No such luck. In fact, while the abominable Dr Chairsatan and Messrs Frost Sack are spouting garbage about economic recovery to anyone retarded enough to listen (oddly they have found a great audience in Congress) behind the scenes they are telling banks to prepare for a stress test recession scenario in which unemployment is 11%. And since current unemployment is about 23%, and we continue to be in a Depression, we assume this means that the Fed is actively preparing to make sure banks will be able to handle the explosion in economic growth and, oh yeah, hyperinflation, when the $1.7 trillion in excess reserves as of June 2011, finally flood the market. Although since this statement may be sufficient to get Zero Hedge to issue "unsolicited" opinions on the state of the Great Ponzi, we will go with the party line here... Which we find confusing: why would the Fed force US banks to undergo another stress test: aren't they all massively overcapitalized? Wasn't that the whole point of the first fraud of a stress test back in 2009 which had he same credibility as the upcoming European one? And why not cut to the chase and conduct a Ponzi unwind stress test? So many questions...So many more lies.

A well-trodden meme of TV and cinema has been the plot in which someone or something uses tantalizing illusions to sap humans of their will to resist while simultaneously pursuing hostile ends. In The Martian Chronicles, the subtle race of Martians distracted the invading Americans with irresistible life-like illusions that spoke to their most intimate yearnings. In one episode of the X-Files, a fungus slowly digested an unlucky couple who lay in a field and were rendered completely passive by the fungus’ hallucinogenic properties. And then, most famously, the machines of the movie The Matrix ruled over a ruined wasteland and seduced people with a beguiling virtual reality in order to maintain their passivity while they tapped humanity’s body heat as an energy source. Now, a lot of investors believe that life is imitating art in an alliance of the Federal Reserve and the big banks to create the illusion of healthy equity markets despite massive retail equity withdrawals in the years following the financial crisis.

Tom DeMark, whose Sequential and Combo indicators are among the most used indicators by professional technicians and chartists on Wall Street, is out with some chilling words overnight. The Market Studies LLC president told Bloomberg that U.S. stocks are within a week of “a
significant market top” that is likely to precede a drop of at
least 11 percent in the Standard & Poor’s 500 Index. “I’m pretty confident that in one to two weeks, the market
will be in a descent,” said DeMark, founder and chief executive
officer of Market Studies LLC. “It could be pretty sharp.” And since the Hindenburg Omen in mid-August was prevented from taking its share of scalps only by dint of the Chairman's Woods Hole speech a week later which set off the market on the biggest melt up since... well August of 2009, we wonder if the Fed's Open Market Operations desk will take this warning as a leading indicator to start spreading rumors of another QE expansion. Keep a close eye on those Jon Hilsenrath "leaks."

About two weeks ago we brought attention to the curious case of surging Chinese SHIBOR. Today we update on the short and longof it (literally). Indeed since the first post, the short end has dramatically tightened. However, just as importantly, the long-end continues to drift wider. As the chart below demonstrates the 1 Week SHIBOR has plunges from north of 6% to the mid 2% range in about ten days. However, both the 1 and 3-Month rates continue to be sticky and are well above recent averages. This will certainly portend continued liquidity scarcity in the months ahead. And speaking of, interest rates, we would like to bring attention to the seemingly paradoxical and contradictory action being taken by the PBoC, which on one hand has been hiking the Reserve Ratio Requirement (liquidity withdrawing) while concurrently adding liquidity via net liquidity injections through Open Market Operations. As Morgan Stanley's Steven Zhang suggests: "The PBOC’s purpose appears to be to substitute RRR hikes for PBoC bill issuance and repos with a view to enhancing the effectiveness while keeping the cost of liquidity management low." Yet even so, Zhang confirms that the end result will be one of incremental tightening, no matter how much the PBoC wants to moderate liquidity extraction. "Even if the spreads between reference and interbank spot yields were to narrow to acceptable levels, we don’t believe that the scale of open market operations would be restored to normal levels. In this tightening cycle, liquidity management will largely become a one-way operation - withdrawal." In other words, look for more pain in the Shanghai Composite over the coming weeks as mainland investors realize that the inflation party is, indeed, coming to an end (and that to Bernanke's chagrin, all attempts at exporting inflation to China will henceforth rebound with a magnified impact).

Over one year after Zero Hedge made POMO, and the Fed's open market operations group a household name, and Brian Sack a household curse, the NYT has finally decided to write an expose on the people who are charged with enforcing America's transition to central planning. And they just happen to be the grizzled 40 year old Mr. Sack, a 34 year old supervisor, two 29-year olds and a 26 year old ... who goes to NYU. Yes, ladies and gentlemen, these are the people who are gifting billions in commissions to the Primary Dealers on a daily basis. You see, the FRBNY whiz-kids have a "computer algorithm that works out which [offers] to [lift]. The computer compares the offers from Wall Street against market prices and the Fed’s own calculation of what constitutes a “fair value” price." In other words, taxpayers are getting raped during each and every single POMO but that's ok - the Fed's algorithm, probably created by yet another ex-Goldmanite, determines that said raping is "fair" and with absolutely no transparency anywhere in the process, except of course the Fed telegraphing in advance what bonds will be monetized, there is no way to ever check... Because that kind of mutually assured destructive disclosure would mean the financial world would promptly implode in a case study of total protonic reversal. After all, only smart people (and we are talking Wall Street smart) can handle the responsible truth... of daily Primary Dealer Subsidies.

After the Fed bought over $1 trillion of US Treasury bonds in the past 2 years, it is now reverse payback time, in which the Fed gives the Treasury just a little more cash. The FRB announced that per "unaudited" 2010 results (obviously), the Fed is provisioning to pay the Treasury $78.4 billion, a 50%+ increase from the $47 billion paid to the Treasury in 2009. What is the basis of this payment? Why the Fed's charter of course: "Under the Board's policy, the residual earnings of each Federal Reserve Bank, after providing for the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in, are distributed to the U.S. Treasury." Which means that as the Fed buys up ever more Treasurys, and as rates continue their inexorable rise higher, the Fed will continue to receive interest payments from the US Treasury, which, at the end of every year, it will promptly remit back to whoever the current incarnation of Tim Geithner is, in essence nullifying the "checks and balances" impact of cash out interest expense on Treasury, and thus government, deficit decisions. In fact, the greater the amount of debt issued, and therefore monetized, the less the Treasury actually has to pay in interest. And in the meantime, the higher interest rates go, the greater the duration-adjusted loss on Fed holdings. But who cares about those: after all, results are all "unaudited" and the Fed will hold all securities to the earlier of "maturity" or default - as if anyone doubts which will happen first.

A few days ago some were very surprised by the previously announced decision from the SNB that it the bank would cease accepting Irish bonds as collateral. Considering that the Swiss National Bank is now the only responsible institution left in Europe, now that floundering Jean Claude Trichet is willing to accept even used condoms at a 120% LTV as long as they have a sterling CCC- rating by S&P, we fail to see how this is surprising. That said, those same people may be even more surprised that the SNB has just added Portugal to its "restricted" list. The FT reports: "The Swiss National Bank confirmed on Friday that it had stopped accepting Portuguese government securities as collateral for repurchase (repo) agreements, adding Lisbon to Dublin among the eurozone governments on its ineligible list. The decision to exclude both countries follows steep downgrades of Portuguese and Irish debt and was based on the Swiss central bank’s strict, but highly transparent, acceptance criteria." What this means is that on Monday JCT will be very busy BTFD in Portuguese bonds. He will have many opportunities to do so, as everyone holding the paper will be bailing in droves. Furthermore, this disclosure could not have come at a worse time: with Portugal slated to hold another major bond auction next week (following last week's abysmal 6 Month Bill auction), there is actual risk the entire affair could be a failure and set the European sovereign market ablaze, kicking off the 2011 round of "bail out Europe."

In our now globally accepted bizarro world, where problems are priced in before they even appear, disclosing swans of assorted colors becomes a moot point. After all, all the bad news in the universe couldn't possibly matter as long as the irrational exuberance persists. That the higher stocks go, the farther they will crash eventually (and for those with their finger on the sell buttong, good luck selling into a bidless market) is a given, but maybe, just maybe the laws of gravity are different this time. On the other hand, maybe they are not. For those who are convinced that no matter the amount of data fudging, accounting fraud, and dollar debasement that the Fed endorses, nature will eventually take its course, may want to take a look at the below chart of 1 week, 1 and 3 month SHIBOR. In a nutshell: there is no marginal liquidity left in the world's fastest growing economy. Eventually this will dawn on the world. Until then, BTFD.

Today the PIIGS are back at the ECB subsidy trough with Portugal taking center stage with its E500 million 6-month bill auction. The next country to implode sold E500mln of 6-month Bills, and while the bid to cover was just a slightly better 2.6 compared to the 2.4 before, the yield again surged, hitting an unsustainable 3.686% versus 2.045% previously. The net result of this jump in yields is that peripheral spreads have once again commenced leaking wider, with the Greek spreads to Bunds pushing to a new record wide at 974 bps, a 10 point move. This is hardly the last we have heard of record Greek spreads it, and while it is very feasible we will see a four digit spread in the next few days, who really care anymore. After all it is just the ECB that will end up holding the toxic paper.

Following the release of Bill Dudley's daily schedules from the beginning of 2009, through September 30, 2010, there have been some amusing, if not very surprising, disclosures. Among them: Dudley's penchant to meet with Jamie Dimon, Vik Pandit and, of course, former boss Lloyd Blankfein. Other meetings include Sullivan and Cromwell chairman, and the banking cartel's personal chief attorney H. Rodgin Cohen. Those are to be expected: after all Dudley has to conduct the New York Fed policy exactly in accordance with Wall Street's expectations, and per Wall Street's recommendations. What is a little more surprising is that on February 9, 2009, Bill Dudley hosted a lunch roundtable with hedge fund SAC Capital... Perhaps now Dudley knows almost as much about the chances of various Phase II/III drugs to make it to market as ole' Stevie himself. Additionally, on May 14 Dudley invited Ken Griffin and Adam Cooper from Citadel into his office at about 2:00 pm. One wonders just what the quid pro quo between the New York Fed and Citadel may have been, over and above of the traditional dark pool securities purchasing relationship between the two entities of course. Where it gets a little confusing is why Dudley had to have two informal meetings with the man who singlehandedly determines US fiscal and monetary policy: Goldman's Jan Hatzius, first on March 11, and then, less than a month later, on April 6, both times as the Pound and Pence. And where it gets downright bizarre, is trying to explain why Bill Dudley on June 11, 2009, had to bring over one still unknown Brian Sack, now pervasively known as the head of the Fed's Open Market Operations Committee, to not only walk over to Goldman Sachs for a meet and greet (as opposed to Goldman coming over to the NY Fed), but specifically "introducing Brian Sack to the Goldman FX Committee" between 4:00 and 4:30 PM on that day. Just which of Brian's myriad functions is the one that requires the participation of Goldman's FX team? Last time we checked, purchasing bonds and MBS in POMO operations had little if any impact on Goldman's FX trading flow...

The data starkly show a comatose Wall Street being resuscitated with whatever financial might the Federal Reserve could pump into its tangled web of funding vehicles. It also points to how the Fed was dispersing sums which dwarfed the U.S. Treasury’s $700 billion TARP (Troubled Asset Relief Program) bailout program...

This week’s action can be summated in a single question:

Which is stronger, the Euro collapse or the Fed’s Permanent Open Market Operations (POMOs) AKA money pumps to Wall Street?

These are the two primary forces at work on the markets today. Thus, this week’s action will be determined by one of the two:

1) The Euro (the bearish influence)
2) Light volume/ the Fed’s ongoing POMOs (the bullish influence)

The administration's support for Bernanke's "weak dollar" policy is evident in the way that Obama keeps reiterating his promise to double exports in 5 years. This simply can't be done without ripping the dollar to shreds, which appears to be Obama's intention.

There is only so long that the Bundesbank can keep ignoring the fact that it has recently started piling on failed auction after failed auction. Today, Germany tried to sell €5 billion in 2 Year 1% Schatz notes. And while the official tally on the auction was a 1.1 Bid To Cover at a 0.92% average yield, just above our own 3 Year auction yesterday, (and a drop from the 1.4 previously) this was yet another failed auction, as the bank managed to get only €4.33 billion in competitive and non-competitive bids. The kicker: the Bundesbank retained €995 million of the issue, a whopping 20% of the proposed issue size - this is the amount it could not find any buyers for, and the deficit to what have been a non-failed auction. In other words, after the entire world was rushing to buy German paper, suddenly there is nobody willing to get in.