Thursday, September 24, 2009

What was wrong with the FOMC minutes?

So the FOMC minutes were released, the market held firm until...well something spooked a steep sell-off into the close.

What happened?  It wasn't as if there was anything particularly pointed in the minutes.  More a summary of the timidity of the recovery and that policy will need to continue to be supportive.  (You can read it here.)  But there was something in there - I read it as a restatement of the 'exit policy'.

And there's the rub.  We have reached the point where the patient is going to leave rehab - that means no more intravenous drips, no more call button and, maybe to the positive, no more hospital food.  It doesn't mean that there won't be attentive nurses dropping by to offer some comfort but it is homecare for us now.

Consider the following charts of the Fed's open market operations that are designed to pump new money into the system.  First up the agencies where the Fed has committed to purchasing up to $200bn of agency debt and $1,250bn of agency MBS by the end of Q1 in 2010 (as opposed to the end of this year as previously foreshadowed):

In both cases, we are over half way towards to the final purchase volume, but with the slowing down of purchases, MBS acquisitions in particular will be at a markedly lower rate.

(Here I've simply assumed that the balance will be spread evenly across the period to the end of March.)

Now to the treasury purchases that to date at least seem to have had a disproportionately larger impact on risk markets (it'd be great to have a correlation analysis between these tenders and movements in the equities markets but it's beyond my time constraints).  Here we are at the tail end of the planned purchases:

With $10bn left in the kitty, that is to be spent by the end of October, this liquidity injection is all but over.

The Fed can't print money indefinitely.  It needs to engineer an exit strategy.  The withdrawal of the pump priming treasury POMO is designed to achieve exactly this.

Without the artificial bid, the markets need to stand on their own feet.  Given the economic backdrop that prevails, this is not consistent with the return of the raging bull.  Rather expect it to be a catalyst for a sell-off as the market seeks to find the 'new' floor.  If there isn't one - expect the Fed to step up again - with POMO part II.

Finally, out of curiosity I looked at the level of acceptances as against the volume of stock submitted through the Treasury POMO.  I wasn't hoping for much - but was interested to see whether there was a loose correlation with the March lows and recent activity:

It was inconclusive.  The volume of stock offered into the tenders has averaged around $20bn per tender (with pretty large volatility around this - which could be for any number of reasons).  At face value, there does seem to be lower levels of acceptance around the March lows.  And, interestingly, recent history has retraced to these types of levels.  Not sure it means much, but might be worth keeping an eye on.

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