miércoles, 2 de septiembre de 2015

miércoles, septiembre 02, 2015

The Fed Spent $23 Billion In 3 Days, But Still Had A Hard Time Pushing Up Stocks
             
Summary
  • On Monday, August 24th, the Fed injected $18.54 billion from a "reverse repo fund" filled with cash accumulated at the end of QE3.
  • The $18.54 billion was exponentially greater than what has been previously needed to stabilize stock prices.
  • On Monday & Tuesday, primary dealers failed to move stocks up, because overhead resistance was too strong, and a tactical retreat left the DOW down by a combined 793 points.
  • On Wednesday, the Fed added $4.446 billion, and combined with a mildly positive durable goods report, the primary dealers succeeded in pushing the DOW upward by an astounding 620 points.
  • A September rate hike is off the table, but soon the Fed will have to accept a huge drop in stock prices or a return to money printing.

There was a time, pre-2007, when the Fed could move the DOW up or down by 100-200 points merely by injecting or withdrawing a few hundred million dollars. The idea of injecting a whopping $18.54 billion, in one single day, was something that would have been impossible to imagine. Times change...

On Monday, August 24, 2015, the Fed injected more than $18 billion dollars. In spite of that, the DOW dropped by 588 points, and by the end of trading on Tuesday, it was down a combined 793 points for the two days. What I am talking about? I am talking the sudden failure of the traditional methods that the Federal Reserve uses to control the behavior of millions of investors.

How they injected new money into the market, without actually printing any new money yet, requires a discussion of the little known concept of something called "TOMOs" and "REVERSE TOMOs". At the end of QE3, the Fed collected just over $100 billion of the then-newly-printed dollars into a fund composed of "REVERSE TOMOs". As you will see, REVERSE TOMOs work exactly opposite to the manner in which TOMOs work. So, to avoid confusing you, I must get into a discussion of what these two things are.

The Fed has been pushing markets upward by actively printing a lot of money ever since 2001.

The first phase of the printing extravaganza was not called "QE" because, theoretically, the money that was printed was not permanent. Non-permanent money printing is called a "temporary open market operation" a/k/a "TOMO" a/k/a "repo transaction". "QE" is something different. It is officially known as a "permanent open market operation" a/k/a "POMO". To understand what I am talking about, I have to start talking about an area of finance which is somewhat confusing.

TOMOs, or "repo loans" can be thought of as a type of temporary QE. The central bank prints up a quantity of money, usually at the request of its primary dealers, the dealers take the money, and they hand over bonds in return. The money is used for whatever the big banks want to use it for. In practical terms, it is used for influencing stock, bond and commodity price both up and down, depending on Fed policy.

Another transaction, used by the Fed and its dealers is the so-called "reverse repo" or "REVERSE TOMO". In this type of operation, the central bank hands back the bonds, and the primary dealers hand back the money. The process of using TOMO and REVERSE TOMOs to move prices involves catalysis, rather than brute force. Neither the Federal Reserve, nor any other central banker for that matter, has the resources to fight the entire market.

Careful coordinated use of cash, however, can catalyze changes in market pyschology, and that is often enough to change momentum. The primary dealers use the cash to basically "paint the tape", so that patterns are created which provide buy and sell signals to other investors. This allows the Fed to move markets broadly up and down.

Unlike the case with outright QE (POMO's), primary dealers are actually supposed to pay back TOMOs. The repayment myth is why very few people screamed and yelled, between 2001 and 2007, when this method of money printing was the primary one used to fund a rising stock market, and between 2007 and 2009 to slow down the collapse. It was much less controversial than QE because, theoretically, when the money is repaid, it disappears from the system.

Theory, however, often doesn't work in practice, as we'll discuss in a moment. But, before we get into the repayment issue, it is worth a look at how the Fed describes the process:
Among the tools used by the Federal Reserve System to achieve its monetary policy objectives is the temporary addition or subtraction of reserve balances via repurchase and reverse repurchase agreements in the open market. These operations have a short-term, self-reversing effect on bank reserves.
It is hard to remember all the various names for these transactions. Remember, that a "repurchase agreement" results in a TOMO, and a "reverse repurchase agreement" results in a REVERSE TOMO. The idea that these "loans" are "self-reversing" is deceptive. It is only true if they are repaid in a timely manner. If not, the end result is the same as outright QE.

Between 2001 and 2007, TOMOs and REVERSE TOMOs were used as a primary method of pushing markets up and down.

As you may note from the quote, the Fed alleges that the loans are "overnight", implying they are paid back the next day. That cannot be further from the truth. Almost every morning, going back several decades, the Fed has kept itself very busy, by making new "loans" as great or greater than the ones before. The primary dealers repay the first "loan" with the second, the second with the third, and so on and so forth.

The bottom line is that the Federal Reserve does not get paid back for these allegedly "overnight" loans on the next day. Instead, they get renewed by the issuance of new loans, day after day, week after week, and month by month. That way, the dealers can carry out Fed policy until they can finally make money off the money by pressuring markets in the desired direction.

The Fed balance sheet shows an ever-growing balance of repo "loans" given out between 2001 and 2009. Eventually, they amounted to a running balance of hundreds of billions of dollars, constantly rolled over at maturity for almost a decade. It was essentially a Ponzi scheme, except that the central bank was running it, so it could never break down. Instead, it facilitated an endless expansion of the money supply. This manifested mainly in asset inflation, but was also paid for by commodity inflation during the first decade of the 21st century.
According to the Federal Reserve website:
The Fed uses repurchase agreements, also called "RPs" or "repos", to make collateralized loans to primary dealers. In a reverse repo or "RRP", the Fed borrows money from primary dealers. The typical term of these operations is overnight, but the Fed can conduct these operations with terms out to 65 business days.
Remember, repurchase agreements are TOMOs. "Collateralized" is a fancy way of saying that bonds are posted before the Fed gives out the cash. On maturity, the dealers are theoretically supposed to take their bonds back. But, between 2001 and 2009, the Federal Reserve's balance sheet showed an ever-ballooning mass of repo loans. The loans were never paid back. They were simply renewed, over and over and over again.

The running total of hundreds of billions in repo loans was finally repaid ONLY when the primary dealers received newly printed cash when the Fed started admitted to doing permanent cash printing ("QE"). This gradual process began in March 2009. You can review the entire history of the Fed's repo injections, a/k/a "temporary open market operations" a/k/a "TOMOs" here.

When you compare each TOMO to the movement of the DOW, S&P500 and NASDAQ, you will find a very strong correlation between large cash TOMO injections and "up" days. The "T" in TOMO stands for temporary, even though the loans are more or less permanent gifts.

As with POMOs (QE), money is printed, and, as with POMOs (QE) there is an excellent correlation between injection of cash and a rise in stock and bond prices. The correlation is not perfect, of course, because other factors, like a fantastic news day, can offset the need to inject new money, or even allow some to be taken out.

Once QE began, the TOMO process became irrelevant, and was eventually phased out, because the primary dealers no longer needed them. The process of open and obvious money printing provided them with a permanent source of ready cash, and a market for bonds that could not be profitably sold into the free market. The primary dealers have been very successful in using both the TOMOs and the POMOs to catalyze upward movement in stock and bond markets.

In light of that success, retail investors returned to the market, en masse, during the last phase of QE3. In the midst of that euphoria, not all the printed money needed to be injected right away, and the Fed did some REVERSE TOMOs, holding back some of the newly printed QE money, putting together a sort of emergency reserve fund. Remember, REVERSE TOMOs are the opposite of TOMOs. Money was printed in the POMO (QE) process, and then, because it wasn't needed immediately, it was taken back in the REVERSE TOMO process.

In the end, a fund was created that is essentially a collection of surplus cash, left over from QE3. The existence of this pool of money has allowed the Fed to operate in markets, over the last year, injecting and remove liquidity, without being accused of money printing. Remember, in a TOMO, the Fed takes in bonds and gives out cash. In a REVERSE TOMO, it takes in cash and gives out bonds. Again, if you look at the history, on the days the Fed was accumulating the reverse repo cash fund, stocks mostly went down. Whenever the Fed releases cash from the fund, stocks mostly go up or stabilize if they are going sharply down.

The "REVERSE TOMO RESERVE FUND", as I will call it, is a running balance of REVERSE TOMOs, amounting to somewhere between $65 and $120 billion dollars depending on the day.

Remember, the fund is composed of REVERSE TOMOs, not TOMOs. Therefore, when the size of the fund goes down, it means that the Fed has injected cash into the system. Similarly, when the size of the fund increases, it means the Fed has taken cash out.

When you look at the numbers, remember one critical point. REVERSE TOMOs operate in exactly the opposite way the TOMOs did during the period 2001 to 2007. The fund that is being deployed is not made up of newly printed cash. It is made up of excess money that was printed up at the end of QE3 but not used back then. The Fed reacts to falling markets by releasing cash from the fund.

Take a look at the history and you'll quickly discover that stock prices rise when cash is released (the REVERSE TOMO dollar amount will fall as a result) and stock prices fall when cash is taken back into the fund (the REVERSE TOMO dollar amount will rise when cash is taken back). The end result has been to stabilize the stock market at approximately the same level as a year ago. This convinced the average Joe Investor that the good times are here to stay.

Unfortunately, times change. There has never been a successful centrally planned economy in the history of the world. It didn't work for the old Soviet Union, and it won't work for America.

The intense effort to micromanage the American economy, undertaken over a period of several decades, is also due to fail. It is only a question of when, not if.

In "olden times" (pre-2008), injection in the range of $23 billion would catalyze a massive 2,000 point "up" day on the DOW. That's why it was never done. But, now, the Fed is dealing with the implosion of a boom set into motion by a credit bubble it created. It is a whole new ballgame. The dealers and the Federal Reserve, however, seem to have underestimated how much money they needed to reserve, at the end of QE3, in their "Reverse Repo Reserve Fund".

They also seem to have underestimated the amount of cash it would take to change the market's momentum this past Monday and Tuesday.

In spite of injecting $23 billion, the DOW (NYSEARCA:DIA) still collapsed by 588 points, S&P500 (NYSEARCA:SPY) by 78 points, and the NASDAQ (NASDAQ:QQQ) by 170. It was not a total failure. Not yet. Remember, on Monday, the DOW was down by 1,078 at one point. I

t closed down only 588 points. It was fascinating to watch the events unfold. In the early morning, stocks plummeted in almost a straight line. Then, as banks anticipated receipt of the cash, typically delivered at 1:15 pm, stocks recovered.

Stocks reached a peak around the exact time the money was delivered by the Fed. But, when the money actually arrived, the "buyers" began trying to sell. Closing long positions in an orderly manner is essential for the success of a upwardly bound market manipulation. It could have been done, if the dealers had been able to create such chaos. But, it didn't work. Stocks began to head downward again.

In the first part of the last half hour of trading, the longs (I surmise that they are the primary dealer controlled hedge funds) seemed to make a last-ditch effort to catalyze upward momentum. Yet, in an intensely negative sentiment situation, one must quickly sell long positions, or risk getting stuck with big losses. The buyers seemed to try desperately to cover longs before the end of the trading day.

It didn't work again. Once the longs tried to sell, stocks raced down in the last 10 minutes or so of the trading day. It was fairly obvious on Tuesday, the next day, that the Fed was far from finished. The dealers may have staged a tactical retreat on Monday, but they were armed and ready. The futures market was bid up heavily in the early morning hours, and that the indexes were looking spectacular.

As the cash market began trading, however, sellers took over again. The intensity of the selling ended up foiling the longs. Again, the attempt to catalyze upward market movement failed. The DOW ended up down by 205 points. On Wednesday, with the addition of another $4.446 billion in ammunition from a reduction in the reverse repo fund, they finally found success.

The day started off well, with some good news about durable goods. Then, various voting members of the FOMC began telling the public that a September rate hike was "less compelling". The combination of a bit of good news, Fed official jawboning, and with a dollop of extra cash to capitalize on it, the dealers managed to raise the DOW by 619 points.

It will be impossible to maintain this momentum without huge additional cash injections. This is illustrated by the fact that the ISE Sentiment Index, which indicates how many real investors want to buy stocks, printed at a sad 79 at the end of the big rally Wednesday. In other words, the rally was contrived, and additional upward catalysis operations will require larger and larger sums of cash.

All of this leaves the Fed in a pickle. Throwing $23 billion at a falling market, didn't stop the decline of stock prices. If they throw in another $23 billion, every three days, stocks will be suspended for longer, or will fall by a only a mediocre amount. But, this cannot go on forever.

The current "reverse repo fund" has already been drained down to $68.719 billion. That's only enough for a few more trading days. Once it is drained down to zero, the Fed is out of ammunition.

At the zero point, they will be forced to return to either overt money printing (QE) or the covert money printing (TOMOs that are never paid back). Otherwise, there will be a very large percentage decline in virtually all the indexes. We will see either a Great Depression style stock collapse, or a new money printing program. Since "QE" is now a dirty word, they will call it something else. Probably, they will go with the covert TOMO route. In the end, however, it is all the same. They will print money.

Between now and then, you could lose a lot of money. During the period 2001-07, the daily cash TOMO injections typically amounted to only a few hundred million dollars. Now, the injections will have to be exponentially greater. At $20 billion a pop, people will begin to notice, regardless of how covert the Fed tries to behave. The end result will be a loss of confidence in the Federal Reserve.

Money printing, however you call it, has a profound effect on precious metal prices. From 2001 to 2009, for example, when TOMOs were used exclusively, gold more than tripled in response to a substantial increase in the money supply. Later, when the POMOs (QE) began, gold soared to $1,900. Both money printing methods put heavy upward pressure on precious metals prices.

The current administration seems dead set on stopping gold from being a "canary in the coal mine" that lets investors know what is really going on. It appears to have taken the role as "supplier of last resort" in the gold market. Admittedly, it has thousands of tons of the yellow metal. Theoretically, US-owned gold could feed markets for a long time, filling excess demand, and restraining prices against their natural tendency to rise. But, not even America has unlimited resources.

Filling even the current level of supply deficiency will drain the gold reserve to zero in only a few years. And, with the probable loss in confidence in the Fed, the drain will increase exponentially. The gold reserve might not even last a year after that. It is unlikely that the powers that be, desperate though they may be, will risk everything. They are well aware that gold reserves may be critical in the new monetary world that finally unfolds after this crisis is over.

Precious metals prices will eventually rise dramatically. It is just a question of whether it happens this year or 2-3 years in the future. That's why, right now, buying gold as a long term hedge is your best bet. For those caught still holding stocks, however, the good news is that more cash injections are on the way. It is the only method that the Fed can use to offset the speed by which stocks are falling and it will happen until the Reverse TOMO Reserve Fund is entirely exhausted.

About $68.719 billion remains and it will be used before the Fed considers any more money printing. It is reasonable to expect that a combination of cash injection, jawboning and hyping up of stray pieces of good news will be used, in the near future, to catalyze additional up days.

Some of them may be very large as the Fed opts for a "shock and awe" campaign. Don't be shocked or awed. Get ready to use the opportunity to sell. The long term future is dismal.

Absent money printing, there will be a very large decline in stock prices. We do not yet know the timing. If the decision is to print more money, as is likely, stocks will rise when looked at in nominal terms. However, the Fed will lose so much credibility that the value of the dollar will be greatly impacted. For that reason, a significant delay in making that decision will probably occur. Stocks must fall first, and the techniques they are now using must be proven to be a definitive failure.

It is prudent to use these artificial rally days to get out before the big decline that spurs the Fed into renewed money printing. Then, you can get back in, or choose an alternative investment that will benefit more from the loss of Federal Reserve credibility.

0 comments:

Publicar un comentario