by Lee Adler, Wall Street Examiner
How the Fed Funds the Market
According to the NY Fed, Thursday it bought: US: $3.599B CouponPurchase 2020-09-03 in NY Fed treasury securities operations – AKA Permanent Open Market Operations, AKA QE. There were no operations scheduled for Friday (04 September). The next scheduled operation will be next Tuesday, a small purchase of $1.75 billion.
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I wrote on August 28:
Today’s scheduled purchase is an unusually large one for a single day, $12.8 billion. Ditto for Monday when the Fed is set to buy another $8.8 billion.
That’s because the market must absorb $125 billion in net new Treasury issuance between today and Monday. The QE is a drop in the bucket relative to that. If ever the financial markets were going to have problems in this environment, the next 3 days would be the time.
Seems the market had a bit of a delayed reaction, but that’s already ancient history, with buyers pouring in to buy the dip overnight.
I had also warned about the likelihood of tight market conditions at Liquidity Trader.
Do or Die Week for the Bears
There will be a severe shortage of QE next week to match up with the end of month Treasury issuance. Bears have a shot there, but here’s why things tilt back toward the bulls after that.
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The Fed buys the paper from the Primary Dealers. The Fed pays for the purchases by depositing newly imagined money into the dealers accounts at the Fed. That money is then their cash to use for trading whatever they want. Usually that includes a big slug of equities, in addition to Treasuries and whatever else they make markets in.
The dealers are middlemen, or straw men, acting on behalf of the Fed. The dealers purchase newly issued bills, notes, or bonds from the US Treasury. They in turn sell that paper to the Fed with a markup. That markup is their skim.
That’s how QE works. When the Fed’s QE purchases temporarily fall short of the amount of Treasuries that are being issued, the market still must absorb and pay for those Treasuries. That typically means that the buyers need to liquidate something else, whether existing Treasuries or stocks, usually. It’s a recipe for a selloff in financial assets.
Normally, the Fed creates just enough QE to absorb or fund the absorbtion of almost all new Treasury issuance. The market can only absorb a tiny bit of it on its own. So the Fed does the heavy lifting in this environment where the Treasury is issuing gazillions in new TP all the time.
Think of the Fed as a lift station. That’s a sewage treatment term. You can google it if you’re interested.
This arrangement, where the Primary Dealers act as middle men, enables the Fed to claim that it is not monetizing the Federal debt. But that’s a sham. And it’s out in the open and possible to track. The Fed publishes its purchase schedules in advance.
Likewise the Treasury Borrowing Advisory Committee (TBAC) publishes a quarterly estimate of US Treasury debt issuance by date and specific issue, including bonds, notes, and bills, 20 weeks in advance at the beginning of the second month of each calendar quarter.
There were no MBS purchase settlements Thursday or Friday. MBS purchases are forward contracts which the Fed settles during the third week of each month with settlements on three separate days over the course of one week.
The last settlement for August was on Thursday, August 20. The next one’s will be the week of September 14-21. Should be around $100 billion or so. Those mid month settlements are usually enough to give the markets a nice boost.
Again, the Fed deposits cash into the accounts of Primary Dealers in payment for the prior MBS forward purchases. Again, it’s the dealers’ money at that point. So those MBS settlements tend to support bullish moves in the financial markets.
I track, chart, and analyze this data, including the schedule for coming weeks, and report its likely impacts on the short to intermediate term stock market direction. You can get these reports at Lee Adler’s Liquidity Trader, with updates throughout the month. 90 day risk free trial for new subscribers.
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