My friends at ContraryInvestor have published some remarkable
data this evening in their twice weekly (subscription) analysis of the
economy and the markets. This is one of the best analysis sites we follow,
and highly recommend that you at least take advantage of their complimentary
monthly newsletter.
This data suggests that the Fed's purchases of Market Backed
Securities serves not only to artificially depress mortgage rates and the
longer end of the yield curves. The purchases occur, with a remarkably high
correlation of 86%, during monthly stock market options expiration weeks in
the US.
"...since July, there has only been one options expiration
week whereby the Fed did not buy at least $60 billion of MBS during the
options expiration week itself, providing instant and meaningful liquidity
during options expiration weeks that have historically had an upward bias
anyway! Talk about timing of liquidity injections to get maximum effect in
the equities market."
The data is intriguing to say the least. As you may recall,
option expiration in the US stock indices occurs on the third Friday of every
month. We have pointed out in the past that this monthly event is often the
occasion of some not so subtle racketeering by the funds and prop trading
desks of the banks in separating the option players from their positions, and
pushing prices around to maximize the pain.
Why would the Fed wish to provide extra liquidity, to the tune
of $60 billion or so, for the banks during that week? There must surely be
other ways to support the equity markets. Such as buying the SP futures in
the thinly traded overnight session. I am not aware of a strong correlation
for stock selloffs or extraordinary weakness in option expiry weeks per se.
It might not be a coincidence, but there could be some unrelated
event in the mortgage markets that also occurs on the third Friday or
Thursday of each month. We are not aware of it, but that does not mean it
does not exist. They might also be making the purchases more randomly, but
reporting them on some schedule as the Fed does its H.41 reports, for
example. Anyone who might know of such a cross correlation would be kind to
let us know of it.
Addendum 22 Jan: Several readers have written to suggest that
the Fed is buying in the TBA markets, new issues, and that they have fixed
settlement dates that roughly coincide with stock options expiration. That
does not remove the potential material effect of providing liquidity in
options expiry week, but it certainly does nullify the imputation of
deliberation. I think the front running as noted in the blog today in
Treasuries is more obvious and plausible.
See Also About Those MBS Purchases in Option Expiry
But otherwise, it would be a good question to ask of the Fed.
Are they in fact supplying extra liquidity to the banks at certain intervals
to support a manipulation of the market to boost their prop trading results?
Perhaps at the next occasion of Ben's visit to Congress. Or
maybe the SEC can pick up the phone and call NY Fed CEO Bill Dudley, formerly
of Goldman Sachs. Federal Reserve Bank of New York Tel: (212) 720-5000.
ContraryInvestor is one of the more 'squared away' analysts we
follow, and they do go to some pains to stress their reluctance to ever take
the conspiratorial route. There may be a perfectly innocent reason why the
Fed buys the MBS when it does. Some correlation based on the calendar.
Inquiring minds would like to hear all about it, Revelations-wise.
"...in trying to follow the money we know the bulk of Fed
money printing has gone to support the mortgage markets with the Fed buying
up a huge swath of MBS since March of last year. From the summer of 2008
until the present, the Fed has been a huge help in getting conventional 30
year mortgage paper costs from the mid-6% range to the high 4% range. Quite
the accomplishment.
But if you take a very careful look at the character of the Fed
balance sheet since the big time money printing effort started in March of
2009, you'll see that their buying of MBS has been a bit of a multi-use
exercise. Without trying to sound conspiratorial, we believe they have also
used the MBS buying program to help "support" equity prices by
essentially providing liquidity to the aggregate financial market at quite
the opportune times...
You may have seen that recently Charley Biderman at
MarketTrimTabs has been suggesting that he cannot account in aggregate for
just who has been buying equities since March of last year. He suggests that
although he cannot prove it, the Fed may indeed be a key buyer.
MarketTrimTabs is the keeper of the records of the kingdom when looking at
equity mutual fund flows, etc. We even did a bit of this ourselves in a
discussion a while back by documenting that traditional equity buyers that
have been households and corporations (buybacks) were essentially nowhere to
be found in 2009.
In fact, households were selling and on a net basis corporations
were issuing equity, not buying it back. That leaves institutions, banking
sector prop desks, the hedge community, etc. as the key provocateurs of
equity price movements in the rally to date. No wonder Charley is scratching
his head a bit and wondering just how we could have scaled the largest 10
month rally in market history without households and corporations playing
along. But like Charley, we can prove nothing about the Fed actually acting
to buy equities or futures, etc.
But there just happens to be one thing we can prove when we
“follow the money” that the Fed has been doing. And it ties right
back to their purchasing of MBS in the marketplace. Remember, when the Fed
buys a mortgage backed security from the financial sector, it provides
liquidity that can 1) be lent out, 2) reinvested in other mortgage backed
securities (not a chance), 3) used to buy bonds, or 4) used in prop desk
trading. We already know the lending is not happening, MBS purchases have
been the province of the Fed with few other buyers, banks have bought bonds,
but in moderation, and finally banks are announcing “record trading
profits” as per their prop desk activities. Get it? Of course you do.
The prop desk destination has been a liquidity magnet.
So here’s the important issue regarding the Fed's MBS
purchases relative to equity market outcomes. It’s the timing of the
Fed’s MBS purchases that has been the key support to equity prices. And
we see it that way when we analytically follow the money. Ok, the chart below
chronicles ALL Fed purchases of MBS by the week since March of last year. The
blue line is the ongoing level of Fed ownership of MBS as this position has
been accumulated over the last 10 months. It’s an almost perfect stair
step higher pattern. Although it may seem random, the dates we input into the
chart happen to be the weeks ending on a Friday. Friday's of options
expiration weeks. Notice a pattern here?
Of course you do. It’s blatantly obvious. To the bottom
line, the Fed has been very significantly goosing its purchases of MBS during
equity options expiration weeks. In fact, since July, there has only been one
options expiration week whereby the Fed did not buy at least $60 billion of
MBS during the options expiration week itself, providing instant and
meaningful liquidity during options expiration weeks that have historically
had an upward bias anyway! Talk about timing of liquidity injections to get
maximum effect in the equities market.
Folks, this is right out in the open. No mysteries and fully
disclosed on the Fed’s own balance sheet. And guess what? It gets
better. The second largest weekly period for Fed purchases of MBS outside of
the expiration week itself? You guessed it - month end week. Another maximum
effect week where we usually see institutions engage in a bit of window
dressing. Nothing like providing a few extra chips "on the house",
no?
To put a little summation sign around this section of
commentary, the chart below breaks down the timing of Fed purchasing of MBS
since June of last year. Yes, 86% of all Fed purchases of MBS since that time
occurred directly in equity options expirations weeks. Another 7.8% of total
MBS purchases occurred in final weeks of each month. And an overwhelming 5.8%
of total Fed purchases of MBS occurred at other times.
In following the money, this is the only thing we can prove in
terms of actual Fed actions relative to the equity market itself. A mere
coincidence? Not a chance. As we see it, the Fed printing of dough to buy
back MBS has had a dual purpose. The ultimate new age definition of
cross-marketing? Yeah, something like that.
Now that we have covered this data, the question of "what
happens when the Fed stops printing money in March?" takes on much
broader meaning and significance. Of course the Fed has not directly been
buying equities with their clever and clearly very selective timing of MBS
purchases, but they sure as heck were providing the immediate and sizable
liquidity for "some one else" to do so during equity periods where
they could achieve "maximum effect".
Wildly enough, at least as of last week's option-ex, the Fed was
still purchasing $60B in MBS. So, as we stand here today, there are now two
more options expirations weeks prior to us theoretically reaching the end of
the game for Fed printing and MBS buying. You already know we'll be watching,
errr.. following the money that is.
When/if the Fed stops printing to buy MBS, do we also lose an
options expiration week and month end equity liquidity sponsor? Something we
suggest you think about as we move forward. See why we suggest following the
money is a key theme?
Jesse
Please visit Jesse’s Café Américain
for refreshing news on the markets
|