Before we get to “the thing I didn’t write” but warned about in a variety of ways, here are a few tidbits out of the Fed today.
First off, the Fed pulled $8.75 billion in cash out of the market today in Open Market Operations. They also made a big announcement regarding SOHASO (Sleight of Hand Alphabet Soup Operations).
As the mainstream financial infomercial media dutifully reported, the Fed announced that it will increase the size of the twice monthly TAF auctions to $75 billion from $50 billion, intimating that the Fed is again adding liquidity to the system. That wasn’t true in the first place, but why let a little thing like truth get in the way of financial market manipulation, marketing, and distribution. My guess is that they will yet again do it with SOHASO, simply taking the quarters out of one ear to make them disappear in the other, rather than adding any net liquidity to the system. The process probably started with today’s $6.25 billion reduction in repos outstanding along with the outright sale of $2.5 billion in Treasuries from the SOMA. I suspect that there will be more outright sales and redemptions announced next week, although sooner or later the Fed will probably have to revert to Print mode.
The Fed also announced that it will be expanding the collateral accepted under the TSLF (Term Securities Laundering Facility) to include AAA rated Joe Sixpack Asset Backed Securities (Sixpack ABS). As everybody knows by now, AAA rated “stuff” is the highest quality paper, which means that it sells for at least 50 cents on the dollar.
Here we go again. Nice deal for the holders who get to swap out Sixpack ABS collateral for Treasury collateral. Not that that’s any better, with the way the US Government’s finances are collapsing, but at least it’s probably a little better than the credit card debt of US Americans, and such as, who are trying to sell their stuff on eBay to buy gas. Unfortunately, finding the eBay stuff market oversupplied, they aren’t generating any cash to make those AAA credit card debt payments, hence the Fed offers to take the credit card lenders off the hook.
What next, Payday Loans?
Now, to the I Didn’t Write This But Warned About It Ad Nauseum department, the Treasury this week posted the quarterly report of the Treasury Borrowing Advisory Committee, and it is UGLY, confirming virtually everything that I have been droning on and on and on about for the past 6 months in the Professional Edition Fed and Treasury Report. The statements by the TBAC are so sobering and so stunning in their scope that it’s hard to believe that the Ministry of Truth would have allowed its publication. Since it’s in the public domain, rather than summarize and editorialize, I am herewith reposting it for your gruesome enjoyment, in all of its sweeping grandeur, less some of the more technical passages. Read it and weep. If you want the blanks filled in and the lines read between daily, please join us in the Professional Edition daily Fed and Treasury Report. Try it risk free for 30 days.
And now, the pea ace day ghghay cease tongs.
Dear Mr. Secretary:
Since the Committee’s previous meeting in late January, credit conditions have remained stringent and the economy has weakened. Overall, Federal Reserve policies have proved effective in forestalling a financial market crisis by effectively eliminating the possibility of another bank failure but concerns remain about the appropriate quoting of money markets rates, term financing and continued proper functioning of the money markets in the absence of these Fed programs. Expectations for economic growth in the first half of 2008 have continued to fall and a number of primary dealers judge the economy currently to be in recession. Housing remains a notable drag through a variety of channels and that weakness now is being augmented by a more cautious approach to spending by businesses and consumers. Forthcoming tax rebates likely will boost consumer spending in the months ahead but that lift will be temporary. On balance, the outlook for the economy will remain uncertain until credit conditions improve and financial intermediation begins to function more smoothly.
Inflation has remained somewhat elevated due to ongoing price increases for food and energy. Slowing economic growth has had a moderating effect on an array of other consumer prices, especially for credit-sensitive goods such as motor vehicles and household durables. Core consumer prices are increasing in a 2% to 2-1/2% range. Chances favor some improvement in these measures amid tight financial conditions, softer home prices and higher unemployment. Nonetheless, rising food and energy costs’ possible effect on inflation expectations may sustain concerns about inflationary pressures.
The steady tightening in financial conditions has led the Federal Reserve to lower the federal funds target rate to 2-1/4%. Futures markets anticipate another quarter-point reduction in the policy rate, followed by a period of stability. The shift in investor expectations for the path of monetary policy has contributed to the recent rise in market interest rates and the flattening of the U.S. Treasury yield curve.
The Federal government’s budget balance is deteriorating in fiscal year 2008. Weaker economic activity has dampened the pace of revenue collection and lifted growth in economically sensitive spending. A recent survey of primary dealers estimates that the deficit for the 2008 fiscal year ending in September will exceed $400 billion with some economists expecting a deficit of more than $500 billion–a significant deterioration from fiscal 2007’s deficit of $163 billion. Economic stimulus measures will complement the forces widening the budget deficit. This year’s shortfall may surpass fiscal year 2004 as the largest on record in nominal dollars.
In its first charge to the Committee, the Treasury solicited our advice and recommendations for Treasury issuance over the near and intermediate term given the aforementioned deterioration in the fiscal budget outlook.
As a near-term solution, there was universal agreement on the Committee that the Treasury should introduce a 52-week bill to its auction schedule. A “year bill” would reduce the Treasury’s reliance on large cash management bills and provide sufficient financing to absorb the increased borrowing needs that have grown so quickly over the last year.
There was also universal agreement on the Committee that the Treasury needs to prepare for additional financing needs over a more intermediate term. In fact, several members argued that the current deterioration in the fiscal outlook might be more than temporary and that the risk of further deterioration outweighs the risk of a surprise improvement in the deficit.
Furthermore, additional members again reiterated their concern that this latest “cyclical” deterioration in the fiscal outlook is particularly troublesome as the longer-term “secular” forces of entitlement spending and the aging of the baby boom generation and their effect on the budget deficit are no longer that distant in the future.
Consequently, there was strong agreement on the Committee that the Treasury consider altering its issuance calendar over the intermediate term to account for these forces.
The Committee recommends that the Treasury review its issuance calendar and increase the size and the frequency of existing coupon issuance over the coming quarters in addition to the near-term solution of adding a year bill. Several members noted that the increased reliance on Treasury bills, as the deficit has deteriorated, has shortened the average maturity of the debt, and that steps should be taken to arrest this trend, if not, to purposefully reverse it.
The majority of members believe that the addition of the year bill combined with increases to the size and frequency of existing coupon debt over coming quarters will still not be sufficient to satisfy the increased financing needs of the Treasury over the intermediate and longer term.
Consequently, most members recommended that the Treasury prepare the markets for a re-introduction of a coupon note over the coming quarters. The Committee was somewhat divided as to the maturity of such a note. A 3-year note was suggested by some given its relative ease of issuance, while longer-dated notes were suggested by others who are concerned with the shrinking of the average maturity of the debt as argued above.
In any event, the Committee was in strong agreement that the Treasury cannot view the deterioration in the fiscal deficit as “temporary” and must plan for increased flexibility of bills and notes over coming quarters to ensure a continued effective financing environment.
In its third charge to the Committee, the Treasury asked for our views of recent initiatives taken by public and private entities to address the problems in the U.S. housing sector.
Committee members were in agreement that the problems in the housing market were significant, and many were concerned that without intervention the problems would grow worse. In fact, housing price data from S&P/Case-Shiller was released hours before our meeting and highlighted that the decline in housing prices is not over but that prices are actually accelerating to the downside. For example, while year-over-year prices were reported to be down almost 13%, prices on a 6-month, 3-month and 1-month basis have declined 21%, 25% and 28% annualized, respectively.
Several members voiced their endorsement for the Frank/Dodd bill that is currently in Congress. One member noted that while none of these bills are perfect, that this proposal is certainly focused on the key problem which is encouraging lenders and borrowers to find an alternative to foreclosure which serves few interests and might in and of itself fuel housing price declines and create additional defaults.
While few members argued against the “intent” of the proposal, several people articulated their concerns that embedded in such proposals are many unintended consequences. One such concern that otherwise able borrowers would be incentivised to default to capture the same benefit as the borrowers targeted by this legislation.
Several members noted that one of the key issues to encourage servicers to modify loans in hopes of preventing default and foreclosures is the legal liability associated with these actions given the disparate interests embedded in a securitized loan. A number of members recommended that Congress indemnify the servicers while at least one other questioned the long-term impact of what is essentially a repudiation of contract law.
In the final section of the charge, the Committee considered the composition of marketable financing for the April-June Quarter to refund the $74.0 billion of privately held notes and bonds maturing May 15, 2008, the Committee recommended a $15 billion 10-year note due May 15, 2018 and a $7 billion reopening of the 30-year bond due February 15, 2038. For the remainder of the quarter, the Committee recommends a $30 billion 2-year note in May and $31 billion 2-note in June, $20 billion 5-year notes in May and June, and a $10 billion re-opening of the 10-year note in June.
For the July-September quarter, the Committee recommended financing as found in the attached table. Relevant figures included three 2-year note issuances monthly, three 5-year note issuances monthly, a 10-year note issuance in August followed by a re-opening in September, a 30-year bond in August, as well as a 10-year TIPs note in July, and a 20-year TIPs re-opening later that same month.
Keith T. Anderson
I would just add that the TBAC also recommended that the Treasury would need to sell several massive long term Cash Management Bills in May and June totaling over $100 billion. My bet is that the actual amount to be raised will be greater than the TBAC estimates, in keeping with the trend of the Treasury overshooting the estimates by significant amounts week in and week out for the past 9 months. This will further roil the money markets where upward pressure on rates has already been in evidence since April 14, the Fed’s action yesterday notwithstanding. The Fed is spitting into the wind here.
Stay up to date with the daily machinations of the Fed, Treasury, and foreign central banks in the US market in the Daily Fed report in the Professional Edition, Money Liquidity, and Real Estate Package. Try it risk free for 30 days. Don’t miss another day. Get the research and analysis you need to understand these critical forces and stay a step ahead of the markets. Click this link and get in RIGHT NOW!
Join the conversation and have a little fun at Capitalstool.com. If you are a new visitor to the Stool, please register and join in! To post your observations and charts, and snide, but good-natured, comments, click here to register. Be sure to respond to the confirmation email which is sent instantly. If not in your inbox, check your spam filter.