That’s right. The Fed is doing POMO again. POMO means Permanent Open Market Operations. It’s a fancy way of saying that the Fed is buying Treasuries, pumping money into the financial markets.
Over the past 6 days, the Fed has bought $8.6 billion in T-bills and coupons. These are the first regular Fed POMO Treasury operations since the Fed ended outright QE in 2014.
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Who is the Fed buying those Treasuries from?
The Primary Dealers. Who are the Primary Dealers? I’ll let the New York Fed tell you:
Primary dealers are trading counterparties of the New York Fed in its implementation of monetary policy. They are also expected to make markets for the New York Fed on behalf of its official accountholders as needed, and to bid on a pro-rata basis in all Treasury auctions at reasonably competitive prices.
The Fed is Doing POMO, Injecting Cash Into Primary Dealer Accounts
When the Fed buys Treasuries from the Primary Dealers, the Fed pays them by depositing money in the dealers’s accounts at the Fed. When the dealers get cash from the Fed, you know what they do with it! They do their business. They deal. They use the cash to accumulate inventory, whether Treasuries, stocks, or whatever else they make markets in.
The dealers have had a big problem lately. They’ve been forced to accumulate unusually large inventories of Treasuries, particularly this month. That’s because the Trump Regime and the rump Congress agreed to lift the debt ceiling that had been in force since March.
The Treasury market is under assault, being deluged with new supply. Amazingly, the Treasury market hasn’t buckled. It has had the benefit of a worldwide capital flight into Treasuries as foreign economies and markets weaken. Negative interest rates have also helped drive European capital into Treasuries.
Until early August the Treasury market also had the benefit of hundreds of billions in T-bill paydowns flooding dealer and investor accounts with cash. That game ended when the debt ceiling was lifted a few days ago. The Treasury market no longer has that tailwind. Now, a massive flow of new supply creates an equally large headwind.
Fed Had No Choice When the Debt Ceiling Was Lifted
So the Fed had no choice. It had to do something, and that something was to end its balance sheet bloodletting early. Allowing it to continue to run, even at the reduced rate of $35 billion per month, would have only added to market pressures.
Those pressures have manifested in a series of vicious selloffs and gaps in stock prices over the past 15 days. In these markets where liquidity is in short supply, the declines triggered equally vicious countermoves. Whether by the good graces of PPT intervention, or simply due to short covering of futures shorts, we don’t know.
More likely it was some combination of the two. Treasury Secretary Minichin is no fool. He knows the game. Triggering short squeezes is child’s play for him and the PPT team, given the tools at their disposal.
More Fed POMO is Coming
That $8.6 billion in Fed POMO this week is a mere downpayment. There will be plenty more to come.
Over the current 15 day span, some $55 billion in Treasury holdings in the Fed’s System Open Market Account will mature. The Fed will now replace all of that by rolling it over at the weekly Treasury auctions.
Under the prior balance sheet bloodletting (normalization) regime, $35 billion of that paper was allowed to mature and roll off the balance sheet each month. That drained liquidity from the system. Now, none of it will be drained. While there will be no nominal net gain for the banking system, removing a negative is a positive for relative to the prior policy.
The Fed has also committed to buying Treasuries to replace its MBS holdings that get prepaid. This is the driving force behind this week’s POMO.
The collapse of bond yields means that mortgage rates have also plunged. Mortgage refinancing is surging as a result. MBS prepayments are therefore also surging. The Fed’s holdings are shrinking fast.
To replace these lost MBS holdings, the Fed has committed to buying up to $20 billion per month in direct purchases of Treasuries from Primary Dealers. Any amounts of MBS prepayments above $20 billion per month will be replaced with purchases of MBS, again directly from Primary Dealers.
It doesn’t matter what the dealers are selling to the Fed. What matters is that they get cashed out. It takes some of the pressure off them from the requirement that they accumulate Treasury supply.
Without help from the Fed, they must finance 100% of those purchases with repo. That would put upward pressure on interest rates. The Fed can’t have that!
The nominal purpose of these POMO operations is to keep the Fed’s balance sheet level. That will keep central bank created money in the banking system level, rather than falling as it did under the Fed’s balance sheet bloodletting program.
More importantly, this POMO will pump badly needed cash into Primary Dealer accounts. The big question is, “Will it be enough?”
I Answer the Question for You
It’s a question that I address day in and day out at Lee Adler’s Liquidity Trader. In addition, my Technical Trader reports specifically address how those money flows are impacting stock prices and how market trends are likely to play out as a result.
To stay informed about these forces, you can try either the Liquidity Trader reports, or Technical Trader, or both, risk free for 90 days.
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