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

The Fed completed its last POMO monetization for the week, buying back $1.415 billion in bonds dated 2021 through 2040. Oddly enough, the submitted/accepted ratio was a mere 5.98, after hitting north of 10 for the last three POMO actions since the resumption of QE. Stocks now rolling over as the Fed's liquidity appears to have been digested. More importantly, Morgan Stanley continues to shine in its Fed frontrunning recommendations: the firm predicted 89% of the issues monetized by notional, correctly identifying $1.265 trillion worth of the $1.415 Tr in notional bought back. All who followed Igor Cashyn's advice to Buy the 8.0% of 11/15/2021 and sell the On The Run 10 Year (and seeing how at $1.135 Tr monetized, this was the issue most clearly "in play", quite a few did) should find the Morgan Stanley analyst and buy him a shot of vodka.

BofA's Jeffrey Rosenberg provides the breakdown of the total amount of securities that roll off (MBS, Agency and USTs) over the next 12 months: the total is $340 billion, including the $230 billion (and possibly more) in MBS. Alas, this means that on a straight line monthly basis (and the finally outcome will likely be far more jagged), there will be on average just under $30 billion a month in incremental 2-10 Year Treasury Purchases. As Joseph Abate said earlier, this is not nearly enough to be considered a new stimulus, and at best seeks to retain the status quo. What is notable is that BofA believes today's action should have been priced into the market. Judging by the kneejerk reaction in stocks and bonds, the reality is anything but.

Barclays' Joseph Abate adds to the recent confusion over what path of QE (if any) the Fed will decide on at its August 10th meeting, and flatly disagreeing with Nomura which as we noted last week is now convinced the Fed will advise of further loosening in its language, believes that neither MBS roll offs (telegraphed earlier by Jon Hilsenrath), nor lowering the IOER to 0.00% will be sufficient to do much if anything to boost the economy, and instead he believes that the likely path the Fed will take is to allow the Supplemental Financing Program (which currently holds $200 billion in untouchable reserves on the Treasury's book) to roll off, by ending the 56-day Bill auctions, thus pushing almost a quarter trillion dollars into the banking system which can then be used to buy any combination of beta > 5 stocks. The result of this, according to Abate, "would likely push bill and repo rates well into the single digits." Of course with the 2 Year already at almost south of 0.50% one wonders just how much further along the curve does the Fed hope to have its impact felt. Could the Fed merely be trying to steepen the 2s10s by forcing 2s to zero? At this point, nothing would surprise us.

As reported yesterday, the ECB today completed a weekly liquidity withdrawing operation consisting of Fixed Term Deposits, to "remove" the excess cash obtained from €51 billion worth of sovereign bond purchases. This was the sixth consecutive such auction, and the sixth consecutive decline in the bid to cover. 67 bidders participated and submitted total bids for €71.559 billion, to take down €51 billion, or a 1.40 Bid To Cover, which was another sequential decline compared to last week's €47 billion in take down after €71.078 in total bids, or 1.50 bid to cover. The weighted average allotment rate was 0.31%, with a maximum rate of 1% and a marginal rate of 0.4%. With another auction next week, and then many more, all dependent on the amount of debt that Spain et al place "successfully", we expect the Bid To Cover to decline consistently, until we hit a 1 BTC and the ECB realizes its monetization program is a failure.

The ECB has announced its weekly Term Deposit Auction to be held tomorrow will be for an incremental €4 billion, bringing the total variable tender to €51 billion, compared to last week's €47 billion. This simply means that as of Monday, €51 billion in sovereign debt has been monetized by the central bank. As always, this is a liquidity circle jerk, in which the auctioned deposits are eligible collateral for any other ECB credit operations, thereby not having any liquidity-reducing impact whatsoever, even as more Spanish, Portuguese and Greek bonds are purchased by JCT.

The world's undisputed monetization grossmaster (Electronic Liability Outsourcing rating of around 1.8 trillion), representing Wall Street, the Federal Reserve, may be about to see some stiff championship title competition from the little Central Bank that could - the ECB, in a blitz (and very much blind) game of quantitative easing. In a speech, that not too surprisingly missed all the main wires earlier, Fitch head of sovereign ratings, Brian Coulton, warned a banking conference, in discussing the ECB's monetization activity to-date, that "there has been an unwillingness to follow through, and markets are going to want to see the ECB's money. It will require hundreds of billions in my opinion." Which means that Bob Pisani will report on many "extremely successful" Spanish bond auctions over the next year or so, as the ECB buys up every single primary issuance not just out of Madrid, but every single country in Europe, where the non-subsidized (i.e. private) capital markets are now officially dead. Courtesy of Greece, and the fatal decision to bail it out, the Eurozone will one day be described in textbooks as the greatest ponzi scheme ever created (or, at worst, joint in first place by the Fed).

Yesterday we announced the ECB's plan of €16.5 billion in liquidity withdrawal via term-deposits. What we missed is that this is one of the biggest circuitous monetization schemes imaginable as these very term-deposits are eligible as collateral against the ECB's repo facility. In other words, this is very much like pulling oneself out of the toxic asset swamp by one's bootstraps. It gives the impression of a liquidity tightening event when in reality it could easily become leveraged loosening. And here we were thinking that the ECB could go ahead and do something sensible for once. Expect reprisals from Germany once it is understood that toxic bond monetization by JCT is now implicitly permitted.

And so we get one step closer to the end. Look for bond yields in Europe, and especially the Bund, to roll over and accelerate to infinity as investors realize what monetary prudence capitulation is. Amusingly, the KomIntern won - comrades Lenin, Stalin, Marx, Engels, and all others who grace the dark pages of US historybooks, would have been celebrating if only they were alive today: May 9, in addition to "victory over fascism" day, is now also "victory over capitalism and free markets day." Rejoice comrades!

Ultimately, as my colleague Dylan Grice writes, I think we head back to double-digit inflation rates as governments opt to default. I certainly again expect to see CPI inflation above 25% in the UK and indeed in most developed nations in my lifetime ? I have happy memories of the three-day week and doing my homework by candlelight. In the near term, however, the deflationary quicksand will suck us ever lower until we suffocate. A key driver for underlying inflation remains unit labour costs. While unit labour costs decline at an unprecedented rate, they are sucking us inevitably into a Fisherian, debt-deflation spiral. Only then will we see how far policymakers are willing to go to debauch the currency. Last year saw them cross the Rubicon. Monetisation is now the policy lever of first resort.

- Albert Edwards, Soc Gen

Minneapolis Fed's recently appointed president Narayana Kocherlakota had his first public speech before the Minnesota Bankers Association. His remarks on the economy were significantly much more cautious than some of the other Bernanke sycophants. While the Fed President espouses the need for bank regulation by the Fed (to be expected, the inverse would be equivalent to mutiny), Kocherlakota is much less sanguine than his Fed colleagues about the prospects for the $1+ trillion in excess reserves and how these may lead to (hyper)inflation in the future. His remarks that the only way to fix the debt excesses: increased taxes and debt monetization (even more so than to date), should let many readers reconsider just how appropriate the Fed is to regulate a system which never changes but keeps on keeping on, changing absolutely nothing in its policy approach, and merely hoping that a rising stock market (with or without its invisible hand) is sufficient to fix everything.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.

High Frequency Trading coming to a Joe Francis-produced, soft-porn torrent near you.

Mark the date: October 29, 2009. It will be characterizied by a drop in futures for a few minutes followed by a rapid and inexplicable pop on no news, courtesy of last ditch attempt by the Fed to "liquify" the market thanks to $1.6 billion devalued portraits of George Washington. And poof, just like that... Treasury purchases are gone (until Bernanke wakes up on the wrong side of the bed and wants to see Dow 36,000).

"Finally, I would observe that Congress provided the Federal Reserve with a great deal of independence in order to ensure that control over the nation's money supply is not influenced by short-term political or partisan pressures - pressures that could otherwise result in the temptation to use the government's money-creating authority to finance government expenditures (including budget deficits). Such "monetizing" of the debt - that is, financing deficits or paying off the national debt by printing more money - would lead to rampant inflation. I, therefore, support the independence that has been carved out for the Fed in matters of monetary policy to protect against that kind of abuse." Senator Jon Kyl