Did TOMO Rape The Market – Part Deux

Well to some this may be a long read, but I think it is imperative in understanding FX and our fiat based S&P. Some of this is review, but the data is a bit different.

EDIT- kindoff embarrassing, but my TOMO amounts are off… they are millions, not billions. Which makes this ENTIRE analysis pretty much useless- cheers Volar

I will start off and discuss TOMO.

Well, we often talk POMO, but what about TOMO? No, it’s not about some European laundry detergent. By TOMO we refer to temporary open market operations. Yes, the ones that are “supposed” to be monetarily neutral. I have kept track of the Fed’s assets for some time now, and over the past month found myself a bit in a conundrum. The NY Fed lists all auctions and auction results (here & here), but the FRED, St. Louis does much detailed accounting. Now there is currently a major discrepancy between the FRED’s ~55B in reverse repos (TOMO) and what is being reported by the NY Fed. The St. Louis data shows a spike HERE and HERE.

Now why do we care? Well, lets look at the TOMO Reverse Repo Sales (bi-weekly). Is it just me or does a few billion seem to correspond with market collapses?

We all know, due to POMO (second chart), that selling assets has horrid consequences for equities. Now a monetarily neutral trade should mean nothing, correct? Wrong(ish)! The counterparty(s) of the TOMO (reverse repo from the FED), totally hosed the fed for about 100-300bps on $55B (depends on the bond). Congrats to whomever pulled this off. I wish I knew who, and how much, but  I dont have the auction results Brian???? The one thing I do know is it was classified as (1) a reverse repo (fed asset sale, to buy back at higher price), and (2) a “Foreign Official and/or International account”

First I will address the international account part.

Clearly the data does not match up. This would pertain to Part 3 of my “potential scenario analysis” below. Or I cannot say that the FED did a central bank liquidity swap with the ECB over the past month. Which also jives with this on FRED. However, who is to say it is not our currency crunching friends over at the Banque Nationale Suisse?

Ok on to my scenarios (feel free to add or subtract).

(1) The counterparty(s) knew the market was going to eat crap and made a bet. But how and why 55B from Brian?

(a) Either the counterparty(s) could not find a way to get 55B into SPOOS and the like without (1) transaction costs being too high or (2) Slippage of 55B ruing the returns (potentially a problem, but not necessarily). I mean if there is no auction…and it is just a free FED trade… slippage and transaction costs are not exactly an issue, are they? The Fed is an open door to anyone (who is accepted under the NY Fed’s application), to take a <15 day asset swap (reverse repo). So maybe the counterparty(s) just decided to use the FED? Buy the FED’s “debt stuff” and return it at a higher value. Make sense if you are long high duration bonds and are expecting the VIX to spike say 30 or so? If this were a legitimate open market, transparent, competitive bid auction, slippage would still be an issue- even trading with the FED. However, I don’t have the auction… Brian?

(b) Maybe the counterparty(s) know something about liquidity. Or lets presume that in 2008 (latest big TOMO), somebody knew that by drawing liquidity out of the system for a few days, one might spook the market. Now I understand that the RPs are monetarily neutral, but what if the fact that dealers just hear the words “Fed selling 55B” just plain scares the piss out of the market. Why? well if someone has 55B to use in 15 days… LONG high duration bonds… they have a pretty darn big directional bias don’t they… Or if you, say 10 years ago, saw Soro’s adding large shorts to the mark, you would not follow?

(2) The second scenario pertains to Ben and Brian. Maybe even our beloved, job creating (sarc), politically desperate president. Forgive my lack of authentic confidence in our transparent (hmmm… Brian, we don’t see those auctions on the NY Fed website, but FRED has them???), autonomous, fiat based, liquidity sensitive economic system. Or in other words, Ben knows that POMO is ending (obviously bearish in the past), but also knows that if there is no panic, he and others have no political support for extend and pretend. I am not a nut, I am just simply saying that that scenario cannot be ruled out.

(3) FX has caused some international current account issues… say CHF? By that I mean maybe the Swiss tried to have a 55B swap to help lower the CHF (theoretically). That would jive with the international accounting issue found on FRED (again data here && here). However, why would it not show up in the central bank liquidity swap here?

OK so that is up for EvilSpeculator and ZeroHege aficiondas to go find out. I have obviously done my part.

*** Now on to how this pertains to trading.

Clearly there are obvious implications, but I like math, data, and charts.

First lets look at simple US POMO less US TOMO (sales only) on a rolling 30 day summation.

Well it is apparent that the market is not just sensitive to POMO, but TOMO. The spike in the Fall of 2008, was not a POMO drain, but a TOMO drain.

Now for the Forex junkies.

First lets look at ECB net OMO. By net I mean liquidity providing less liquidity adsorbing.

Ok so clearly there is some correlation.
Now on to a net difference in US and ECB.

Clearly as long as ECB> US POMO, less US TOMO (reverse repos sales only), the Euro has selling pressure.

If QE3 is large, well, the dollar may go lower.

And a reminder for commodity bears/bulls:

So bottom line: watch the FED.

-Volar