Via e-mail, I received Tyler Durden’s post on supposed Fed stealth monetization of debt via an allegedly stealth repurchase of a big chunk of the Treasury’s latest 7 year bond issue on the Fed’s open market desk.
Full disclosure: Tyler Durden has been a guest blogger here, I think he often does a very good job in covering technical trading matters where the significance of their activities might escape the layperson, and is quite diligent at using his access to information not in the possession of most bloggers or journalists. So he does provide a very useful service. But having said that (and I have told him this privately and it has been pretty much ignored) he tends to hyperventilate, which discredits him even when he has a legitimate target. And he does not seem to know the limits of his knowledge, and will also take on issue where he does not know enough to discern what is significant and what is mere noise.
So to today’s object lesson, This is the bulk of Durden’s post; feel free to click through and view the snapshots and few additional comments:
In a brilliant piece of investigative reporting, Chris Martenson (original article here) has uncovered that the Fed, merely a week after issuing $28 billion in 7 year bonds (which Zero Hedge discussed previously) via its puppet, the US Treasury, of which $10 billion ended up being purchased by primary dealers, has turned and bought 47% of the primary allocated bonds in Open Market Purchases. This is undisputed monetization removed simply via one primary dealer and less than 5 days of temporal separation in order to leave no easy trace. As Martenson points out:
“A more honest and open approach would have been for the Fed to simply buy them outright at the auction but this way, using “primary dealers” and “POMOs” and all these other extra steps the basic fact that the Fed is openly monetizing US government debt is effectively hidden from a not-too-terribly inquisitive US press and public.”
The question is did the Fed implicitly tell the primary dealers they are merely holding the treasuries for a flip, and that it would acquire them immediately. Absent this $4.8 billion in effectively monetized bonds, what would the Bid To Cover have been for the primaries? Would this have been the second practically failed auction for USTs after the deplorable 5 year auction results a day prior? One wonders if there would have been 62% indirect interest in these bonds (which the day before had a measly 32.5% indirect bid) if the purchasers were aware of the Fed’s immediate prompt monetization of a large part of the directs’ balance.
Now I do not pretend to be a bond market or a Fed operations maven, but I know enough to know this analysis is a crock.
You cannot conclude ANYTHING about whether the Fed or any central bank is adding or draining liquidity by looking at a single day of open market operations! You need to look at what has been happening over a period of WEEKS AND MONTHS, and not just supposed Now if someone did that analysis (which is even though it is only simple addition, is still pretty painstaking), they might indeed prove that the Fed is monetizing beyond the $50 billion a month it says it is buying in Treasuries. But one day of activity on the open market desk proves precisely nothing. And the fact it bought the new issue? If it did want to buy something (and you’d need to look, as I said, at the whole pattern, repo rolls as well as “permanent” open market operations, since the Fed has used repos to mask liquidity mopping-up operations in the past).
And why would they buy the recent 7 year issue? Because it was the most recently offered, and therefore the most liquid! Duh!
A real bond market maven, John Jansen, took a dim view of the Martenson assessment:
The principal reason for the Open Market Desk’s purchase of so much of just one issue is simple and uncomplicated and it is not part of some Byzantine conspiracy. The Federal Reserve responds to that which the dealer community offers to them. Since the 7 year note was just auctioned the street would own far more of that issue in the narrow sector in which the Open Market Desk was operating today than of surrounding issues.
So to complete the operation quickly and cost effectively, they would opt to buy that issue. Pretty neat and surgical and quick.
I guess I am not so good at marketing myself as I wrote about this on April 2, 2009. So there is absolutely nothing unique or special about today’s transaction by the Open Market Desk.
The reporting and discussions on the topic at some of the other blogs contain factual errors which should make one suspect the bona fides of the authors on this topic…..
The author (Tyler Durden) makes the statement that the Federal Reserve bought the bonds just one week after issuing the bonds. Anyone with a modicum of understanding of the process knows that the Federal Reserve does not issue bonds. The bonds are issued by the US Treasury and then the Federal Reserve purchases them in the “open market”.
Some will counter that the distinction is one without a difference but in discussing such an esoteric topic and in presenting oneself as expert on that topic one should get the facts absolutely correct. So to make the egregiously incorrect statement that the Federal Reserve issued those bonds should be a warning signal that the author has waded into an area where he lacks some expertise regarding fundamental and elemental facts.
At that point I would stop reading the story…..
Mr Martenson asserts that the Federal Reserve has quietly bought the bonds and secreted them away on its balance sheet. (That is nearly verbatim.) Well it does not appear that they did it so quietly or so secretly as he was busily posting the results of that transaction and discussing it in the blogosphere not very long after the transaction took place.
Mr Martenson also avers that a more honest and direct approach would have been for the Federal Reserve to buy these bonds directly in the auction.
Let me say that I am not entirely certain on the next point but at 1120PM I feel confident enough to write it: I believe that the Federal Reserve can only buy securities from the Treasury when it rolls over maturing holdings. The Treasury only resurrected the 7 year note in March and consequently the Federal Reserve would have no bonds to roll in the auction. Ergo there lack of participation.
I will make certain of that point in daylight hours tomorrow.
I get things wrong now and again, but when I know I am writing in areas where I am not certain of my knowledge or my sources, I signal that be either saying I am sticking my neck out, by offering multiple theories, or by toning down my language. And I do correct posts or add updates (once in a while, early leaks from MSM sources have been spectacularly erroneous). I worry that this sort of reporting will only serve to diminish the credibility of blogs generally.
Update 4:00 AM: An anonymous reader pointed out that Jansen softened some of his original attack:
I do think I owe Zero Hedge a bit of an apology as I misinterpreted his comments about the Fed issuing bonds. On a rereading I see that he makes the point that the Treasury is the issuer.
While Jansen strives to be fair, he was correct in singling out the sentence that got him going as being off base, even if his attack was off target in its particulars. Durden called the Treasury the puppet of the Fed. That’s completely backwards. Read Willem Buiter. The Fed has been acting as an off balance sheet entity of the Treasury, or what he calls a quasi-fiscal agent.