The Cost Of Twisting (And The "Housing Recovery"): $100 Billion In Foregone NIM To The Primary Dealers

When Operation Twist began in late September 2011, Primary Dealers reported that their net position in bonds with a maturity between 1 and 3 years was ($23) billion or the biggest short since January 2010, while reporting holdings of bonds between 11 and 30 years of $12.4 billion, for a net carry position (Short minus Long) of $(35) billion. What a difference just over 6 months makes: courtesy of Treasury Primary Dealer data, we now know that in the preceding weeks, with the Fed selling paper maturing in under 3 years, the Primary Dealers have loaded up to the gills on short-dated maturities, and in the week ended April 11, they reported $54 billion in 1-3 Year Holdings (a number which will surge as it comes very shortly after the traditional end of quarter window dressing when Dealers convert all their liquid holdings into cash to make their capital ratios more attractive for reporting purposes). At the same time 11-30 Year Maturities declined from the $12.4 billion at the start of Twist to just $7 billion: don't forget - this is the only type of bonds sold by the Fed (if also including short maturities than the explicit long-end that the Fed is buying).

What is interesting is that with nearly 80% of Twist over, the 10 Year was at just under 2.00% the day Twist started, and was....just shy of 2.00% on Friday, or unchanged over 7 months. In other words in order to "sterilize" the Fed's duration extension, keep rates, and the price of gold, low and promote a "housing recovery" (which keeps forgetting to appear as it is not the ratio of mortgage debt to disposable income, or even cost of mortgages that matters, but the mortgage debt service ratio to housing equity which has not budged one bit, but more on that shortly) Dealers have been "forced" to part ways with about $100 billion in Net Interest Margin generating units, as the Short minus Long position has risen from -$35 billion to +$54 billion, hitting over $60 billion a few weeks ago.

The bigger issue is that as we noted before, the Fed is running out of 1-3 Year securities which it can sell, and at the end of Twist will have at most two more months of inventory left, which in turn means that any further easing will no choice but to be unsterilized. As usual the market, and those securities most sensitive to whether future monetization is sterilized or not, will figure this out late to quite late.

But probably the most important Twist-related chart is the following from Bank of America, which shows just how much interest rate risk the Fed is taking on: over the duration of Twist, the Fed has basically soaked up all the issuance of debt (in terms of 10 Year equivalents) over 10 Years. Which also means that if and when rates spike up, not only will the Fed be impacted (at about $2 billion DV01 per most recent Fed holdings), but all the additional proceeds will be transferred to the Treasury. In fact, the higher the spike in rates, the more "profit" that the Fed will remit to the US Treasury. Is it possible that, in their stupidity, this is precisely what the authorities hope happens, as the convexity impact of rising rates on 30 Year paper will be much greater than on the belly and lower which is what the Treasury is most exposed to from a cash interest expense perspective?