When we provided our advance look at today's dual POMO day we said that: "while we expect Dealers to go balls to the wall in flipping the just auctioned off 10 Year reopening in the form of Cusip QN3, their interest in flipping the recently auctioned off QS2 will be far more muted." As a reminder, this is predicated by our interpretation of Bill Gross' tweet from last Monday, that "QE3 [is] likely to take form of "extended period" language or interest rate caps on 2-3 year Treasuries [sic]" and a result Dealers who believe Gross' prediction will hold off on flipping On The Run just issued bonds, a practice widely espoused across the curve up until the date of Gross tweet. Indeed, we already saw that during last week's 2 Year POMO not a single OTR was flipped back to the Fed, an outcome which at the time puzzled us (we had not noticed Gross' tweet). Well, the results are in... and we were half right. As we predicted, there was not a single OTR 3 Year bond (the QS2 Cusip) sold to the Fed by the dealer community during the just concluded 2:00 pm $4.6 billion POMO: a development in stark contrast to events as recent as 2 weeks ago, when the then 3 Year On The Run QM3 was massively flipped back to the Fed, just a week ahead of Gross tweet. Yet we were also half wrong: we expected that guided by Gross' expectation that the upcoming "Operation Twist 2" would focus on the front end (2-3 Years), would mean major flipping of the OTR 10 Year, as per the first POMO today. Wrong. In fact, just as during the 3 Year POMO, not a single 10 Year OTR (Cusip: QN3) was sold to Brian Sack. It appears that Dealers are now virtually certain the Fed will proceed with some form of Operation Twist, but are simply unsure whether the Fed will focus on the 2-3 Year Space, or go all the way to the 10 Year: the point that David Rosenberg predicted would be the threshold for interest rate caps. That this is happening despite a substantial drop in yields, and thus profit, for all the Dealers who hold the OTRs since auction day (both the QN3 and QE2) makes the case all that stronger. The FOMC announcement this Wednesday just got very interesting as there appears to be a substantial pricing in of an interest rate cap disclosure in some format, just as Bill Gross has predicted. Translation: that would be the start of QE3, and would explain the paradoxical strength of the Euro in the face of simply horrendous news out of Europe over the past week.
The results from the 3 Year POMO (On The Run 3 Year highlighted):
And the results from the 10 Year POMO (OTR 10 Year highlighted):