Desperate Fed

by Larry Levin

The FOMC announced this afternoon that the Federal Reserve will be joining the central banks of England and Switzerland. It too will start creating money at will to buy long-term government debt so as to keep interest rates low and hopefully boost lending (pushing debt like a dealer pushes drugs) in their ongoing attempt to revive an economy that is faltering badly due to an orgy of debt a few years ago.

In short, all else has failed so Helicopter-Ben is now living up to his nickname; he is printing money out of thin air and dropping it to the banks, then possibly the slack-jawed yokels who have no idea what is happening.

Here is a portion of today's statement: In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

That's right, the Federal Reserve surprised the hell out of the market today by promising to increase its balance sheet today by a whopping $1.25 TRILION. However, the most worrisome portion of this madness is their commitment to buy $300 billion in longer-term Treasuries. The Fed will buy 30-YR bonds directly from the Treasury; one government entity to another! If this sounds odd to you, it's probably because it is. What they are doing is a bit like filling your swimming pool by pumping water from the deep end to the shallow end.

Moreover, the Fed was more pessimistic about the outlook in its statement. Officials removed language saying they expected the economy to recover later this year. So which is it Bernanke; the economy will recover as you said on 60-Minutes, or it won't since you removed that from the official statement? A government official wouldn't lie on TV now - would they?

Why would the Fed decide to massively increase its purchases of GSE debt and new outright purchases of US sovereign debt? The fit may have hit the shan behind the scenes: foreign governments may have had enough and said "no more."

In a recent interview with the Premier Wen of China, Wen told reporters that he was concerned about China's huge stake in the US economy. "We have lent huge amounts of money to the United States. Of course we are concerned about the safety of our assets," Wen said. "To be honest, I am a little bit worried and I would like to...call on the United States to honor its word and remain a credible nation and ensure the safety of Chinese assets."

Does this prove the rumors that China has stopped, or severely restricted, buying US treasuries? Japan has severely limited new purchases, why not China? Maybe it's true, so the FED has resorted to the unthinkable - quantitative easing, or printing money.

The Bank of England executed its first quantitative easing (QE) operation today that resulted in a massive bid-to-cover ratio of between 5 and 7 depending on the source. This means that for every bond purchased 7 were tendered, or made available by willing sellers (the BOE bought outstanding debt from its banks). The BOE now has seen what happens when the government offers to overpay for something: everyone hits your bid immediately!

When a central bank says it will buy up its own debt, it drives the price higher (and the yield lower) because its aim is to drive rates down, therefore it MUST overpay, or rig the market. And like all government actions, once the ball gets rolling, it doesn't stop for a very long time. I expect this $300 billion to be the first of many more purchase announcements and if so, the Fed will wind up owning all of its own government's bonds, having destroyed the private capital market for sovereign debt. It has already done that for other securitized debt by threatening to overpay for those issues.

If this happens, how could we continue to deficit spend? How could we continue spending on anything beyond tax receipts? Finally, what happens when the Fed STOPS buying treasuries? Ka-boom!

The Fed has used the last and final ammo. If it goes sour we'll be saying "stick a fork in us...we're cooked."


Previous Day's Trading Room Results:

Trade Date: 3/18/09

E-Mini S&P Trades*
(before fees and commissions):

1) OTF sell @ 10:00am at 768.50 = +1.50 (1-lot)

2) Algorithm positions (9)...combined SofT and Algo total...+6.25


Electronic (YM) Mini-Dow:


1) Buy @ 10:35am at 7,236 = -5 (1 lot)

2) Sell @ 2:10pm at 7,483 = b/e, +30, +130 (3 lot)

3) Sell @ 2:25pm at 7,391 = -10 & -10 (2 lot)...+$675.00 net



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