Open Market Operations
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.
The dominoes are starting to fall ...
Forget what the Fed is saying ... what is it actually doing?
In fact, just yesterday we had a TERRIBLE 30-year note auction on just $16Bn worth of notes. Already Ben is pretty much the only buyer of Tim’s trash paper and, as that bid to cover ratio drops below 2:1, you’ll see rates begin to tick up dramatically, despite the Fed’s best efforts to contain them and that will put pressure on houses, corporate debt, government debt, municipal debt etc and suddenly we’re Greece.
Various rumblings started at Zero Hedge and a few other fringe sites, and now essentially mainstream (not to mention emanating from such firms as, oops, Goldman Sachs) as pertains to a rather curious correlation between POMO days and market outperformance, appear to have finally gotten to such institutional stalwarts as Bank of America and its traditionally imperturbable Jeff Rosenberg (whose opinion we tend to respect). In a piece released tonight titled appropriately enough, "The POMO Conspiracy Theory", Rosenberg (not to be confused with former M-Lyncher David) sets off to debunk that POMO days have an impact on risk assets. Alas, he fails. The conclusion: "Our analysis points to the correlation, but not causality of POMO with rising stock prices." Sure enough, if one could confirm definitive "causality" of Fed intervention in the stocks markets, that would pretty much be the ballgame right there. And it appears that even his correlation results force Rosenberg to step back: "We likely are about to get a lot more days of POMO if the market’s expectations of $500bn further expansion of the Fed’s balance sheet is confirmed at the conclusion of Wednesday’s FOMC meeting. If the correlation of POMO purchases and stock prices were to continue to hold going forward as it has since August, than we should expect more frequent days where stocks go up as the Fed pumps in liquidity into the financial markets." Thank you for proving our point Jeffrey. Amusingly, at the end of his "debunking", Rosenberg, in typical banker fashion inverts the argument by 180 degrees, and says essentially that even if POMO is goosing markets, it basically creates a self-fulfilling prophecy that "can contribute to a better economic outcome" as it boosts inflation expectations. Jeffrey: a better outcome yes, but for you. And nobody else.
Someone has to lose but, in this case, the loser is the Federal Reserve Bank of the United States of America – which plays the part of the perennial sucker as they are willing to sit down at the table and be taken for all they have two or three days a week. And why are they willing to be so generous? BECAUSE IT’S NOT THEIR MONEY!