Weekly FedBS QE update 06.18.09
Thursday, June 18, 2009 at 08:20PM Greetings fellow inmates:
This was an eventful week in FedWorld Live! President Barack Hussein Obama proposed a financial oversight reform plan that could significantly change the Fed’s structure. For starters, the plan proposes that the Fed’s power to extend emergency funding be subject to approval by the Treasury Department. The plan also stipulates for the creation of a new entity, the Consumer Financial Protection Agency, which would relieve Uncle Benny of his duty to protect consumers from predatory lending. Fed officials have already complained about this proposed change, wanting of course to retain their powers intact. Other areas of the plan do increase Uncle Benny’s power. Obama has suggested that the Fed become the regulator of systemically important institutions. This will include for the first time the federal regulation of hedge funds and private equity funds. This is much more significant change than the previous two, strengthening the Fed’s stake in and control over the financial system. Given Uncle Benny’s pathetic track record in predicting systemic risk, this hardly comforts us. Remember when he was religiously adhering to the notion that “subprime will be contained”? This proposed plan will take some time to pass as it must go through the legislative process. What we do assure you is that this will serve to increase Uncle Benny’s power.
In total, each side of the FedBS grew this week by $30bln. On the asset side, this was mostly due to the purchase programs. Besides the purchase programs, the TALF grew by $7bln. Remember that the TALF is meant to boost consumer lending by supporting the securitization market for that underlying debt. The first auction received no bidders. Though this is expected to pick up, we remain highly skeptical of the efficacy this program is intended to have due to the impairment of credit channels through which it’s supposed to work. Central bank liquidity facilities continued to drop, this time by $15bln. Again, this indicates a reduced demand for dollars worldwide. As last week, we remind you that all the liquidity sloshing around the base levels of the global financial system has reduced the need to procure dollars from central banks. The overall reduction in dollar demand can be seen in a positive light in this scenario. One must be careful however, as it could also indicate a decrease in dollar demand in general, which also aligns well with what we have been seeing for the past few months.
Asset purchases continued this week at a faster clip than they did last time. Treasury purchases totaled $11bln, bringing the total to $566, short of the target of $700bln. Agency purchases continued their smooth ride with $4bln of purchases, bringing the total to $88bln, or about $112bln short of the target. Finally, just as we predicted last week, Uncle Benny resumed his MBS purchases, buying $28bln of those securities. The total for MBS is now $455bln, way short of his targeted $1.25tr.
30-year Treasury yields actually dropped this week, to 4.60 from last week’s 4.70. Of course, one point does not a trend make, and the larger trend is for the yields to rise as QE progresses. This week we also saw the Curious Case of the False Bottom Bonds, in which $134bln of bonds were seized as they two allegedly Japanese citizens were trying to smuggle them into Switzerland. They have since been labeled fake, which put into question many cherished notions about the bond market. If one believes the Treasury’s statement that they are fake, it makes one wonder how many fake bonds there are out there circulating through the system. The Treasury market was apparently unaffected by this news, which can be partly explained by the conspicuously low coverage this got in the mainstream media. Next week should be interesting in the Treasury market, as $165bln of bonds will be auctioned off. This enormous supply could once again pressure yields upwards (though the 30-year won’t be auctioned). We shall see.
The dollar finally broke its nine-week downward streak, by rising from 104.05 to 104.55 according to Uncle Benny’s broad trade-weighted index. We do not consider this a break from the previous downward trend that is still quite evident. You are well familiar with our belief that QE will eventually lead to a massive devaluation of the USD, and we have often said that this preliminary support to our hypothesis given by the correlation between QE and a lower dollar does not necessarily mean the end is near. In spite of our conviction in the long-term prospects for the USD, we have no idea what the immediate future holds in store for the dollar, especially if, as we expect, things take a turn for the worse, economically and financially. We will continue to monitor this.
Commodities, as measured by the Rogers International Commodity Index, dropped nearly 2% this week, perhaps on the stronger dollar. Once again, this is not a breaking of the upward trend, as it is only one data point. The fact of the matter is that commodities remain 32% above their levels around the time QE was announced. As QE progresses and gets ramped up, backing more of the reserve currencies with toxic or otherwise unsustainable debt, investors will flee paper assets and pile into commodities. The initial signals, as with the UST30 and the USD, still point to the fact that QE has been at least partly responsible for this hidden cost to everyone.
Tune in next week for more of Uncle Benny’s zany adventures in BMSTBMM.
MAAA
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Reader Comments (4)
I was thinking about this last night and I wanted to confirm that my line of reasoning was correct. First of all every time the Fed overpays for a toxic security and brings it on to the balance sheet inflation is baked in. Dollars have been printed and paid out for a asset that will not return the dollars paid for it. Ergo when the Fed will be unable to mop up excess liquidity because when they try to sell the assets to mop up the liquidity they won't be able to sop up the amount of liquidity they poured out. So all of the arguments about tightening at the appropriate time are BS and a smokescreen. It simply isn't possible to get this horse back in the barn (assuming the Fed overpaid). All the rhetoric points toward inflation. Did you catch the roundtable on the economist regarding this article by Romer (http://www.economist.com/businessfinance/displaystory.cfm?story_id=13856176). The rhetoric is saying contraction is more dangerous than the threat of inflation. That way when inflation comes Uncle Benny can tell don't worry your little heads; it's better than what would have happened otherwise.
Here is the roundtable http://www.economist.com/blogs/freeexchange/romer_roundtable/
Discipulus, thanks for the link to the roundtable, I had not come across it but have now read it in its entirety. I think your logic is spot on. To be quite frank, I had not really thought about liquidity drainage in terms of over-payment, but it's a very good way to look at things. It is a certainty that the Fed has overpaid for these assets, baking in inflation as you say to a degree. Why can I claim certainty in this regard? Well, all we need to do is look at the relevant ABX indices and see that the assets on the FedBS have not been marked down appropriately. This on top of the minimal haircut imposed even at the time of purchase. Hence, on the opposite end of the trade, when all the treasuries, or money, are supposed to return to the Fed for the assets they were originally exchanged for, it's highly uncertain what price will be used. If the Fed demands the face value, or close to it, that it paid, then it will cause another heap of trouble for the banks. This aint going to happen, so as you say, the horse will not come back in the barn.
For clarification, I also call the MBS toxic assets given the continually depressed housing market. As I've said many times before, what makes any notion of a liquidity drain very thorny is what to do with long-term assets Uncle Benny is purchasing. This is something that was conspicuously absent both from the original Romer article and the roundtable. These cannot be unloaded unto the market, and they wont. The FedBS will not shrink back to its original levels, and it really bothers me how little attention this is given. All talk is about reserve balances counterbalancing the short-term liquidity, which has stopped being the main engine for FedBS growth.
Ultimately, I am 100% in agreement with you about the chicanery going on with rhetoric concerning tightening. Again, as I've pointed out often, we will even see a period when inflation is touted as a magic cure-all for the economic ills before us. Readers are advised to check out the "Inflation" video in our Video Cart. Uncle Benny is a devious guy after all and not only will he create the inflation he so fervently loves, but will even try to sell us on the idea. That is, until it gets out of hand in a hurry and he will just bury his head in the sand.
I believe that originally many were arguing that once the markets "normalized" the toxic assets would regain their "true" value and therefore the Fed would not be hurt and might even possibly profit. This works if and only if the reason that the indexes were and are so low is that liquidity was low or that the securities were simply low because the market was depressed. Of course this sort of argument was always accompanied by a comparison to similar solutions working in Sweden. Sweden of course had a crisis as a small country and not in the context of a global recession. The situation is the obviously not the same with the US. I wonder however how inflation will impact the behavior of the assets on the Feds balance sheet. Although in real terms it will hurt their value it may help their nominative value because it will be easier for payors to keep up on their debts if the dollars value decreases (theoretically of course).