Charting SOMA Twist: Here Is What The $55 Billion In Monthly POMO Purchases Will Look Like Starting ShortlySubmitted by Tyler Durden on 09/06/2011 12:32 -0500
For anyone still confused what Operation Twist is (covered here first about 4 months ago), here is SocGen's Aneta Markovska, charting just what the flawed duration extension will look like (as a reminder, unless the 2s10s is steepened, and at that substantially, we may as well bury the banks: nobody is taking on new mortgages now regardless of where the 10 year is, just look at weekly MBA numbers. However, to make sure the US banking system expires, just flatten the curve completely, and it is game over for NIM). In a nutshell, SocGen believes that the Fed will dump $420 billion worth of 1.5-4 year USTs and use them to purchase bonds with a maturity longer than 4 years - ideally, this would be 20 Years (yes, they would need to be reinstated, and this is our view, not SocGen's) and 30 Years, and sell the 10 years. But since the Fed has zero practical world experience, one can only hope, knowing full well the end result will be yet another TARP to bail out the banks. From SocGen: "The next step from the Fed will almost certainly be for more easing and it will almost certainly be duration extension. The only question is September or November? Prior to the August employment report, the market was split 50/50 on the timing of the announcement. The report pushed the odds in favour of September which is our central scenario.We estimate that at the upper limit, the extension could amount to as much as $420bn in duration purchases, which would make it comparable in size to QE2. However, the Fed may not announce the full amount up front but instead give a monthly run rate and reevaluate at each meeting. Matching the previous run rate, we would expect the Fed to do roughly $55bn per month. This could take the Fed as far as April 2012, at which point inflation should have receded enough to put QE3 back on the table." We are not too sure just who will buy the 1.5-4 year bonds at current yields, but certainly some greater fool than us does and always will exist. What is important, is that dry powder for about $55 billion in POMO recycling will suddenly allow the banks to flip assets to greater fools yet again. As to whether this will work, like last year, we very much doubt it, especially since everyone will be buying gold and crude.
Forget The Twist, Here Comes Operation Torque: Presenting Morgan Stanley's Complete Moral Hazard Profit GuideSubmitted by Tyler Durden on 09/01/2011 10:57 -0500
While we often pick on Morgan Stanley's Jim Caron (the same guy who year after year after year keeps predicting the yield on the 10 year will soar, and not just soar, but soar for all the wrong reasons, such as bull steepening and what not), has just diametrically changed his tune, by bringing us, drumroll please, Operation Torque. To wit: "Policy makers in both the US and Europe get back to work in September, and this month will be rife with deliberations on stimulus and market support policies. In our view, a duration extension to the Fed's SOMA portfolio is an optimal policy tool to engender easing. This can initially be done through extending the duration of reinvestments from MBS and agency holdings but may ultimately culminate in selling shorter-duration USTs in its SOMA portfolio in exchange for buying longer duration assets (‘Operation Torque’, as we at Morgan Stanley have dubbed it)." Why 2 Years? Because as per the August 9 FOMC statement, we know that there will no rate hike for the next 2 Years, and hence no duration risk. Which means that the Fed can sell an infinite amount of paper into a mid-2013 horizon without worrying about demand destruction. And by doing so it will, as we have been predicting since May, expand the duration of its portfolio, in the process pushing investors into risky assets for the third time in as many years. But there is a twist...
Over the past x months, one thing has become all too clear in FX land: the EURUSD must stay rangebound between 1.40 and 1.50, even though as Goldman's John Noyce presents in his latest "not-for-retail" packet, the fair value of the European currency continues to be higher than where it should be. Whether this is a simple case of the tail wagging the dog, whereby the ECB and China are terrified of the downstream effects should the European currency trade under the psychological barrier of 1.40, is unclear. What is clear is that every country in the world has skin in the game, and is forced to keep the EUR in Goldilock rangebound territory: not too low to spook European investors, and not too high to accelerate the German double dip. Some other risk assets correlations observed include the AUD vs 2 year swap spread basket, the VIX vs the S&P, and lastly, on the until recently massively overstretched CHF. Noyce tops it off with some technical perspectives on US govvies and the 2s10s, which is once again diving, although unclear if due to a bullish or bearish flattening.
The Buffett bandaid move, coming 48 hours after Buffett's conversations with Obama, and which also comes oddly enough just 24 hours before Bernanke was expected to announce QE3, succeeds in temporarily sending the stock back to early August levels. It also succeeds in sending the financial sector higher, which as we explained yesterday is the main reason for why the 2s10s had to be steepened, so as a result Operation Twist now can go back to its original formulation of broad 2s30s flattening and result in purchases of bonds across the board. As for what to expect with this surprising move out of Omaha? Absolutely nothing. The $5 billion in cash, unlike Buffett's investment in Goldman, will be laughably insufficient, considering that the bank's mortgage exposure is in the tens of billions, while its litigation liability is another $20-30 billion. This does nothing to change our thesis that BAC will need to come to the market again and again to raise capital. However, as this "raise" confirmed, BAC only has access to private investments: we hope Buffett has very deep pockets to keep doubling down. The other news to come out of this - Paulson will be saved with another deus ex machina and will not need to sell his gold or GLD holdings, removing the liquidation overhang from spot gold. The only good news out of all of this: the taxpayer bailout of Bank of America, when it comes, will be $5 billion less.
Charting The Biggest Structural Problem For US Banks, And What The Market Expects From Jackson Hole, Version N+1Submitted by Tyler Durden on 08/24/2011 20:05 -0500
Sometimes the general public can get confused in attempting to explain the complexities and the inefficiency of the banking sector when one simple chart brings the message home. A chart like that comes from the latest "Eye on the Market" from JPM's Michael Cembalest, who compares total bank deposits ($8.4 trillion), or bank liabilities, and total bank loan (about $2 trillion less) assets, or sources of cash flows that are supposed to fund bank liabilities and generate retained earnings, while the bank performs credit, maturity and risk transformation: a bank's three key functions. As the chart below shows, perhaps the primary reason why the economy is in its current deplorable state, is that instead of lending dollar for dollar to catch up with deposit growth, banks now rely on roughly $1.7 trillion in excess reserves with the Fed, an amount roughly equal to the difference between total deposits and loans, to plug the credibility gap. This also explains why according to Cembalest one of the expectations by the market from Jackson Hole is that IOER will be cut to 0% to promote bank lending, and thus the conversion of reserves into loans (something which the inflationistas out there will tell you is a big risk to a sudden surge in out of control inflation). So how does the Fed's direct intervention in bank balance sheets look like? Here it is.
Operation Twist Expectations (or LSAD) Returning With A Vengeance Explains Today's Moves In Stocks And GoldSubmitted by Tyler Durden on 08/24/2011 14:46 -0500
Whether the Fed will upgrade QE2.5, or "ZIRP through mid-2013", to QE3, or Operation Twist, the form we have been predicting it would take since May, is still unknown: very few people know what Bernanke will say on Friday, minutes after the first revision to Q2 GDP reveals a sub-1% number. What is known is that while cross-asset correlation has soared over the past few days, the biggest driver of stocks over the past few days has been nothing but the 2s10s30s butterfly, which in turn is driven by On and Off rumblings of Bernanke doing the Twist. And here is the rub: when the Fed announces Twist it will be extending duration, it effectively means selling everything 10 Year and older (yes, QE3 could very well be LSAD or Large Scale Asset Dumping instead of LSAP). The goal of this action: make the 2s10s will go vertical and to pancake the 10s30s: a move that the butterfly is now indicating it is once again pricing in - today alone we have seen a massive 15 steepening in the butterfly: a nearly 20% move in the curve. It also explains why gold is being sold off today, because simplistic investors believe that without an actual balance sheet expansion, the Fed will not be diluting paper. Completely wrong: it will merely do so synthetically, from a duration basis. Furthermore, the market will very soon read through the Fed's intention which will be predicated entirely on asset rotation and not on incremental fiat capital. The final outcome will be QE4 where the Fed will have to match the synthetic duration extension with actual cash bond deliverables, namely monetizing bonds, a move which will be even more critical once the deficit spend starts soaring again in the next 3 months. And when it does, it will have to do so double time, to make up not only for previous synthetic exposure extension, but for future priced in moves. In other words, nothing has changed, and we fully expect stocks to soar if indeed Bernanke mentions "duration extension", together with yet another gold dump. The issue is that Op Twist in the proposed format would be physically limited by the amount of 10 Year+ bonds held in the Fed's SOMA. At last check it was not that many at all. So any surge in stocks will be albeit both painfully transitory.
Listening to David Greenlaw and/or Jim Caron as they strike out again, and again, and again, with delusions of economic grandure over US GDP and some historic 2s10s bull steepener which is never, ever coming, one would be left with the impression that Morgan Stanley has inherited the title of most permabullish sell side advisory from Deutsche Bank's economics department. Nothing could be further from the truth. Like any other bank, MS has perfectly hedged its rosy outlook by spoonfeeding its retail clients with the rosy view, while whispering the apocalypse case to its institutional clients (judging by last week's pummeling in MS stock, there is not that many of them left). Below we present the view of MS' equity strategy team under Adam Parker, who gives not only a distribution range for his year end S&P target (1004-1425), but a matrix specifying the probability outcome of either case. Bottom line, "while there is 18% upside to the year-end bull case and 16% downside to the year-end bear case, we assign a higher probability to our bear case than bull case, preventing us from becoming increasingly optimistic." When even Morgan Stanley tells you (or rather the whale clients who are now more than happy to sell into every low volume, retail driven rally) there is little to smile about, it is high time to look for the exits.
What Zero Hedge has been saying for well over half a year has finally hit the mainstream, with pundit after pundit "suddenly" coming out of the closet and making the uber-bold proclamation that "QE3 is here." Yawn. That said, since Goldman's opinion is the only one that matters (see previous posts on this matter, especially those referencing the activities of one Bill Dudley at one "Pound and Pence"), here is Jan Hatzius explaining how the whole world now looks up to Bernanke to pick up the QE torch lit up in the past week by the SNB, the BOJ and the ECB, and take Central PlanningTM to escape velocity (which may well be needed if we hope to get Mars to bail out the Earth shortly). Specifically, when discussing what the Fed will announce on Tuesday, naturally follows Monday, or the day in which risk comes home to roost, Hatzius says the following: "First, we expect them to expand the scope of their “extended period” language to cover not just the exceptionally low funds rate but also the exceptionally large balance sheet. For example, they could rewrite the current forward-looking language in the statement to say that economic conditions “…are likely to warrant exceptionally low levels for the federal funds rate and exceptionally large asset holdings for an extended period” (our suggested change in italics). Indeed, our baseline expectation is that this change will occur at the August 9 FOMC meeting, although it is a relatively close call. Second, we expect the composition of the Fed’s balance sheet to shift toward longer maturities. This could happen via an increase in the average maturity of its reinvestment of MBS paydowns and/or a change in the reinvestment policy for its Treasury portfolio. However, we do not yet expect this for the August 9 meeting, although it is possible." Operation Twist 2 it is then, with unlimited purchases in the 2-7 year range to keep the yield at a sturdy 0%, and the 2s10s to surge record highs (alas, QE3 means inflation, inflation, inflation down the line) in a last ditch attempt to bailout America's financial system, which unfortunately has just entered wind-down mode.
The worst possible news for financials, which basically never managed to tick higher in all of 2011, is now here as the entire Treasury curve has virtually pancaked today, making sure that the perfect storm for banks is here, with nobody trading (no sales revenue), prop trading dismantled (no trading revenue), and no lending revenue soon either (2s10s heading to 0%). The closed loop will send even more money into the 10 and 30 Year, causing even more pain for banks, and so on ad inf until Bernanke relents. And you can be certain that the CEOs of the TBTFs are on the phone with the New York Fed as we speak. Luckily, the next FOMC meeting is August 9 which means the market will only have to deal with this non QE3 uncertainty for a few days. Naturally when QE3 is announced, gold will promptly leave $2000 in the rearview mirror.
While equities are credit closed almost unch from last Friday but at their lows/wides of the week, there was plenty under the surface that clearly signals derisking is rife and discrimination active. HY dispersion and CMBX tranches among others point to some cyclical turning points that do not auger well.
Equities underperformed credit once again as macro protection was in demand (in all asset classes) and some rotation from macro-to-micro protection in equities ended a day which was very ugly open-to-close despite what headlines will yell.
Only a very few names managed gains in both equity and credit today (an interesting bunch - MAR, TOL, HOT, DHI, PEP, and SVU) as homebuilders were interestingly near the tope on the list of better performers in credit (which we suspect was related to the underperformance of the CMBX and ABX tranche markets as well as the higher beta exposure in some of the credit indices). Every sector was in agreement between credit and equity with a deteriorating move today as we note financials, leisure, and media were the worst beta-adjusted in credit relative to stocks on the day. Capital Goods, Utilities, and Consumer Noncyclicals performed the relative worst in stocks versus credit. The up-in-quality theme in credit is increasingly leaking into vol as we saw much less impact higher in vols in better-rated credits than in lower-rated credits. This was also the picture in credit though we did see the very highest rated names underperforming (financials?). This picture was somewhat different in equity-land where BB-rated and below names saw their stocks drop far less than A- rated and above names - once again we think this is to do with both financials dominating performance as well as the typical ratings/momentum correlation unwind.
Contextually , credit and vol were much clearer about their directional view today (deteriorating) than stocks (mixed) . Financials saw modest vol compression but the rest saw vol increase on average at the sector level. Tech, Energy, and Media were the worst (risk-adjusted) performers in credit while Financials and Media were worst on average in stock land (risk-adjusted). Interestingly equity outperformed credit (divergently - as in equity rose and credit widened on average) in Basic Materials, Consumer Noncyclicals, Energy, Healthcare, Tech, Telecoms, and Utilities and the fact that Utes and noncyclicals were the best risk-adjusted performers in stock land suggest less rotation out of stocks and more rotation across sectors today.
It is no secret that since the start of QE2 in November, the US Treasury has issued a gross $890 billion in debt in the form of various Bond, Bill and TIPS. This is cash that the US received in exchange for promises to pay interest and principal at maturity on various series of bonds. At the same time, over the past 5 months, there was $291 billion in debt maturity paydowns, or cash leaving the Treasury and going to those who are lucky enough to receive principal on US debt at maturity. That leaves a net of $589 billion in debt that was issued between November 1 and March 31: money used to fund the ongoing operations of the United States. This is all perfectly public and well-known. After all, every single auction is loudly announced by CNBC at 1 pm Eastern on auction days, with a breakdown between Direct, Indirect and Primary Dealer takedowns. Note that the Fed does not feature in this list of primary issuance bidders as that would be illegal, and would be monetization beyond even any semantic argument that the Fed does not, in fact, monetize. What is less known is that the true action in US Treasurys occurs in the secondary market, or that dominated by the Federal Reserve. Here is where the daily POMO takes place, where as we have noted on many, many, many occasions Primary Dealers promptly flip bonds purchased during a primary auction right back to the Fed. This is where the real source of Treasury funding comes from. And what many may not be aware of is that since the start of QE2, the Federal Reserve has purchased $491 billion of Treasurys in the Open Market (and $556 billion since the start of QE Lite). This $491 billion in indirect monetizations ultimately ended up funding government cash needs. In other words out of $589 billion in net issuance, the Fed has been responsible for 83.4% of the money needed to fund government transfer payments (among many other uses of funds) and keep the US consumer "strong", not to mention funding US defense, education, healthcare and every other aspect of US day to day cash needs. QE2 is supposed to end in precisely three months. During that time the Fed will fund another $400 or so billion in US cash needs. What happens after, nobody knows.
Earlier today, JPMorgan made waves by claiming, some would say rather uncouthly, that Portugal's government is about to keel over and die (even if it is undisputed- after all, on Wall Street no one can hear you speak the truth). Never one to be left wanting, here comes Citi with some charts of "parabolic" moves in the Irish 2 Year bond, and some even scarier claims. As expected any research report that starts with the words: "Oh dear...The picture on Irish interest rate markets is taking a very grim turn" - well, it is clear where it is going from there. In summary, Citi now believes that Ireland is essentially done for, or as Tom Fitzpatrick ever so more diplomatically puts it "things are about to get ugly", and recommends going long CDS since the entire short end of the curve has gone parabolic, now that Europe seems set to watch the island country explode, 2s10s has inverted in the past few days, and overall the Emerald Isle is now a dead man walking in the dumbest game of chicken since the creation of the euro. Too bad neither side is willing to back out, which will ultimately end with the eventual destruction of the eurozone and the euro.