View Full Version : Securities Lending, tinfoil hat mode
The Fed's Securities Lending Open Market Operation:
One way the Fed affects and controls interest rates.
"...the Federal Reserve has the capacity to operate in domestic money markets to maintain interest rates at a level consistent with our economic goals”
-- Ben Bernanke, Fed Chairman, March 26th 2007 to the Senate Banking Committee.
In spite of all the noise lately about what caused the sudden upward move in interest rates like the 10 year T-Bond, virtually no one has pointed the finger at the Fed itself and their "behind the curtain" activities.
http://www.nowandfutures.com/images/fed_seclend_bond.png
The green line is the annual rate of change (with a 13 week moving average applied to smooth it out) on the actual dollars injected via the Securities Lending Open Market Operation of the Fed. The average is about $2 billion per day and goes into the tens of billions on a *daily* basis during significant operations.
The blue line is just a straight 13 week moving average of the same data. It responds fastest of course, since its based on a shorter time period.
The concept, confirmed by various statements by Greenspan, the FOMC minutes and Ben is that the Fed via the NY trading desk can and does affect interest rates. This is a Central Bank, and they have as many billions as is needed to make things like SecLend operations work. If hedge funds and multi-national bank trading desks can make the profits they do and push markets or stocks or commodities around like they can, then the Fed should certainly be able to do the same thing and with more ease.
Do also keep in mind that the NY trading desk, per the Fed itself, trades an *average* of over $100 billion in bonds and bills, etc. *every day* - and that excludes any Securities Lending operation additions.
The basic trading idea is a combination of the three items:
1. Blue line up
2. Green line up
3. Trend line break in a down trend of the 10 year interest rate
It produces a very reliable sell signal (a sell in TBond futures is the same as investing on the basis that interest rates are going up).
The blue line will virtually always precede the green line and is an early warning or alert if you prefer.
Just look at how the blue line starts up before the black line (TBond interest rates) since early 2005 and the green line even usually precedes the interest rate (black line) up move too. The 3rd rule above (the trend line break) is used for confirmation and risk management, etc. purposes.
The bottom line is that in spite of all assertions to the contrary about the Fed's power loss, it's just plain not true as proven by the very high correlation between interest rates and SecLend operations.
grapejelly
06-19-07, 09:40 AM
thanks Bart.
I don't see how it could be true that the CBs don't matter when it comes to money creation. I don't know how non-banks can create money...
Finster
06-19-07, 09:48 PM
The Fed's Securities Lending Open Market Operation:
One way the Fed affects and controls interest rates.
"...the Federal Reserve has the capacity to operate in domestic money markets to maintain interest rates at a level consistent with our economic goals”
-- Ben Bernanke, Fed Chairman, March 26th 2007 to the Senate Banking Committee.
In spite of all the noise lately about what caused the sudden upward move in interest rates like the 10 year T-Bond, virtually no one has pointed the finger at the Fed itself and their "behind the curtain" activities.
http://www.nowandfutures.com/images/fed_seclend_bond.png
The green line is the annual rate of change (with a 13 week moving average applied to smooth it out) on the actual dollars injected via the Securities Lending Open Market Operation of the Fed. The average is about $2 billion per day and goes into the tens of billions on a *daily* basis during significant operations.
The blue line is just a straight 13 week moving average of the same data. It responds fastest of course, since its based on a shorter time period.
The concept, confirmed by various statements by Greenspan, the FOMC minutes and Ben is that the Fed via the NY trading desk can and does affect interest rates. This is a Central Bank, and they have as many billions as is needed to make things like SecLend operations work. If hedge funds and multi-national bank trading desks can make the profits they do and push markets or stocks or commodities around like they can, then the Fed should certainly be able to do the same thing and with more ease.
Do also keep in mind that the NY trading desk, per the Fed itself, trades an *average* of over $100 billion in bonds and bills, etc. *every day* - and that excludes any Securities Lending operation additions.
The basic trading idea is a combination of the three items:
1. Blue line up
2. Green line up
3. Trend line break in a down trend of the 10 year interest rate
It produces a very reliable sell signal (a sell in TBond futures is the same as investing on the basis that interest rates are going up).
The blue line will virtually always precede the green line and is an early warning or alert if you prefer.
Just look at how the blue line starts up before the black line (TBond interest rates) since early 2005 and the green line even usually precedes the interest rate (black line) up move too. The 3rd rule above (the trend line break) is used for confirmation and risk management, etc. purposes.
The bottom line is that in spite of all assertions to the contrary about the Fed's power loss, it's just plain not true as proven by the very high correlation between interest rates and SecLend operations.
Oooo, what fun in bond land!
One question, however. You say that the SecLend line corresponds to "acual dollars injected...". However, if dollars are being injected into the market, shouldn't that make interest rates fall, not rise? For sure, if somebody with infinitely deep pockets came to our town and started handing out free money, no lender would be able to charge interest for a loan.
Also, recall that the Fed's policy rate fell to 1% in the Great Greenspan Inflation of 2001-2004. Even the ten year yield had a 3 handle. In contrast with Volcker's Great Disinflation of 1980-1982, which was characterized by very high rates, near 20%. And this is a global pattern - the hallmark of the JCB's reflation has been holding rates near zero for years.
In other words, high interest rates have always been been associated with monetary restraint, and low rates with monetary ease. What you seem to be saying here is the exact opposite - that the Fed is handing out loads of free money in an effort to push rates higher.
What am I missing?
Oooo, what fun in bond land!
One question, however. You say that the SecLend line corresponds to "actual dollars injected...". However, if dollars are being injected into the market, shouldn't that make interest rates fall, not rise? For sure, if somebody with infinitely deep pockets came to our town and started handing out free money, no lender would be able to charge interest for a loan.
Also, recall that the Fed's policy rate fell to 1% in the Great Greenspan Inflation of 2001-2004. Even the ten year yield had a 3 handle. In contrast with Volcker's Great Disinflation of 1980-1982, which was characterized by very high rates, near 20%. And this is a global pattern - the hallmark of the JCB's reflation has been holding rates near zero for years.
In other words, high interest rates have always been been associated with monetary restraint, and low rates with monetary ease. What you seem to be saying here is the exact opposite - that the Fed is handing out loads of free money in an effort to push rates higher.
What am I missing?
I promised myself that if you responded, I wouldn't mention bond-age... but I lost. ;)
But to your questions - the control exerted by the NY Fed's trading desk on the bond and bill markets does indeed go both ways. Money can be used to push markets either way, although it's certainly easier to push something down with more money. Also note that the T-Bill portions of daily SecLend operations lately have been higher than normal... while the 3 month T-Bill rate has gone down. I don't believe that's a coincidence.
More directly (and you may not have as devious a mind as I hope and think ;-), if someone offered you $10 billion worth of bonds of various maturities how would you push rates up on those or other maturities? The key here is to keep in mind that it's your job to do what the FOMC wants... and that you've been "educated" by Keynesians and believe it, etc.
I'm not actually trying to be obtuse here - you may very well be able to add to my own understanding in the area. My best hint is basic supply & demand factors apply.
On the other question, I'm actually saying that the Fed (with SecLend) is in the business of "helping" rates to go where they need to in order to fulfill the current short term purposes of the Fed. It's also not directly related to monetary tightness or ease - these are short term operations designed for specific purposes and targets.
And before someone has a hissy fit (not you), I'm not maintaining that the Fed is the be-all and end-all of interest rate control either. There are lots of other valid factors.
I'm also saying that the SecLend actions are hidden by their basic unbelievability and also by the lack of following the tenets of conventional wisdom in the area of what can and does affect interest rates.
In an odd way, that quote from Bernanke (and Greenspan, etc. too in various transcripts of FOMC meetings) is almost literally the truth... and how weird for the Fed to tell the precise truth, and have it not be believed and noticed.
As far as your comments about periods before 2000, I don't know if SecLend operations occurred before then - just plain no data is available about SecLend prior to 2000 from the Fed. So I have no comment or even observation, other than that there were certainly other tools available and in use prior to 2000. I will tease a bit though and note that the BoJ/JCB also has a SecLend operation...
Lastly, "SecLend" is my own coined term just for convenience and typing ease. I've never seen it used by the Fed or anyone else.
Finster
06-20-07, 07:57 AM
I promised myself that if you responded, I wouldn't mention bond-age... but I lost. ;)
But to your questions - the control exerted by the NY Fed's trading desk on the bond and bill markets does indeed go both ways. Money can be used to push markets either way, although it's certainly easier to push something down with more money. Also note that the T-Bill portions of daily SecLend operations lately have been higher than normal... while the 3 month T-Bill rate has gone down. I don't believe that's a coincidence.
More directly (and you may not have as devious a mind as I hope and think ;-), if someone offered you $10 billion worth of bonds of various maturities how would you push rates up on those or other maturities?…
Just want to break in here because I think you’re at least circling in on the nub of my question. If it were cash the Fed were offering in exchange for bonds, and if the Fed were offering copious quantities of it, that would indeed put downward pressure on rates (upward pressure on prices), and put cash into circulation. But here you’re suggesting it is bonds on offer in exchange for cash. That’s quite the opposite. That would add to the supply of bonds, putting upward pressure on rates (downward pressure on prices), and subtract from the supply of cash.
Perhaps you didn’t mean to apply "dollars injected..." to this context?
The key here is to keep in mind that it's your job to do what the FOMC wants... and that you've been "educated" by Keynesians and believe it, etc.
I'm not actually trying to be obtuse here - you may very well be able to add to my own understanding in the area. My best hint is basic supply & demand factors apply.
I’m truly not trying to be obtuse here either … [shock]. And as far as understanding goes, we are firmly into BartLand here. I’m pretty comfortable with bonds and securities, but happily defer to you on matters of Fed machinations, money supply…
On the other question, I'm actually saying that the Fed (with SecLend) is in the business of "helping" rates to go where they need to in order to fulfill the current short term purposes of the Fed. It's also not directly related to monetary tightness or ease - these are short term operations designed for specific purposes and targets.
And before someone has a hissy fit (not you), I'm not maintaining that the Fed is the be-all and end-all of interest rate control either. There are lots of other valid factors.
FWIW, I don’t think you are out in tin-foil-hat land very far at all on this. The Fed has great power over interest rates, quite directly at the short end of the yield curve, less directly at the long end. I can’t speak for everyone that makes such comments, but if IMO if the Fed's is suffering any "power loss", it’s not on its ability to influence the value of the USD and USTs. It may want certain things to happen but not want to take the actions that would be necessary to bring them about, but that’s not quite the same thing.
For example, the Fed in all likelihood actually wants inflation to come down, and it could absolutely make it happen. The only problem is that it doesn’t want to pay the price. The inflation we have now is the consequence of past Fed choices in favor of near term comfort over long term economic health. Well, now the "long term" is here, and now the Fed has to pay for its past malfeasance (unfortunately, along with most of the rest of the United States of America). It wanted inflation when it was having most of its effects on the stock and housing markets; and now in order to get rid of the inflation it has to be willing to see prices fall in those markets. It doesn’t want that. But it the run it can only affect the overall price level by affecting the value of the dollar. It can’t elevate some prices without the rest eventually following suit. If "power loss" refers to the ability of the Fed to do that, it never had it in the first place.
Just want to break in here because I think you’re at least circling in on the nub of my question. If it were cash the Fed were offering in exchange for bonds, and if the Fed were offering copious quantities of it, that would indeed put downward pressure on rates (upward pressure on prices), and put cash into circulation. But here you’re suggesting it is bonds on offer in exchange for cash. That’s quite the opposite. That would add to the supply of bonds, putting upward pressure on rates (downward pressure on prices), and subtract from the supply of cash.
Perhaps you didn’t mean to apply "dollars injected..." to this context?
Yes, there sure could be a word choice or semantics issue involved.
The actual mechanics of a SecLend operation are that:
1. It's an auction
2. It's actual short term lending of bonds and bills mostly to the 22 primary dealers of the Fed
3. The FOMC determines how much to "inject" into the daily auction
4. The interest rate paid by those with successful bids is around 1%
My best hint still remains in the basic supply & demand factor area. In other words, if the banks can use the billions in borrowed Fed securities in various trades, artificial supply or demand results - thereby raising or lowering rates.
FWIW, I don’t think you are out in tin-foil-hat land very far at all on this. The Fed has great power over interest rates, quite directly at the short end of the yield curve, less directly at the long end. I can’t speak for everyone that makes such comments, but if IMO if the Fed's is suffering any "power loss", it’s not on its ability to influence the value of the USD and USTs. It may want certain things to happen but not want to take the actions that would be necessary to bring them about, but that’s not quite the same thing.
For example, the Fed in all likelihood actually wants inflation to come down, and it could absolutely make it happen. The only problem is that it doesn’t want to pay the price. The inflation we have now is the consequence of past Fed choices in favor of near term comfort over long term economic health. Well, now the "long term" is here, and now the Fed has to pay for its past malfeasance (unfortunately, along with most of the rest of the United States of America). It wanted inflation when it was having most of its effects on the stock and housing markets; and now in order to get rid of the inflation it has to be willing to see prices fall in those markets. It doesn’t want that. But it the run it can only affect the overall price level by affecting the value of the dollar. It can’t elevate some prices without the rest eventually following suit. If "power loss" refers to the ability of the Fed to do that, it never had it in the first place.
Well put, and I agree, especially about long term fundamentals and affecting the value of the dollar and the box they're in... with the possible exception of an implication about affecting long term rates. It's more a matter in my opinion that they don't want to, rather than whether they could pull it off or not... and I'm pretty sure you agree. I'm just dealing with a fine point that may cause confusion for some.
Finster
06-20-07, 12:05 PM
Yes, there sure could be a word choice or semantics issue involved.
The actual mechanics of a SecLend operation are that:
1. It's an auction
2. It's actual short term lending of bonds and bills mostly to the 22 primary dealers of the Fed
3. The FOMC determines how much to "inject" into the daily auction
4. The interest rate paid by those with successful bids is around 1%
My best hint still remains in the basic supply & demand factor area. In other words, if the banks can use the billions in borrowed Fed securities in various trades, artificial supply or demand results - thereby raising or lowering rates.
And "artificial" being a key term here! When you are allowed to create currency from nothing, you have the power to transfer wealth to yourself from all others holding dollars. And you needn’t go to the voters for tax increases!
Well put, and I agree, especially about long term fundamentals and affecting the value of the dollar and the box they're in... with the possible exception of an implication about affecting long term rates. It's more a matter in my opinion that they don't want to, rather than whether they could pull it off or not... and I'm pretty sure you agree. I'm just dealing with a fine point that may cause confusion for some.
It wouldn’t be the first time the Fed has more directly intervened in the long end of the UST curve, for sure. Usually it keeps it fairly low key, but in the WWII years the long end was managed overtly. What puzzles me is what the Fed would be trying to accomplish. If it openly fretted about long rates resisting its "tightening" efforts a year or so ago, why would it only now be trying to goose them up? It’s been talking about inflation risks (what risk???!!!), but also appears to be concerned about the housing market, which is obviously closely tied to longer UST rates. Can you make any sense out of it?
It wouldn’t be the first time the Fed has more directly intervened in the long end of the UST curve, for sure. Usually it keeps it fairly low key, but in the forties the long end was managed overtly. What puzzles me is what the Fed would be trying to accomplish. If it openly fretted about long rates resisting its "tightening" efforts a year or so ago, why would it only now be trying to goose them up? It’s been talking about inflation risks (what risk???!!!), but also appears to be concerned about the housing market, which is obviously closely tied to longer UST rates. Can you make any sense out of it?
I maintain that the Fed has been "managing" rates since the '40s for all sorts of different reasons and purposes. SecLend is just one of the more recent methods they use.
You asked the right question too. In my opinion, the recent SecLend operation was all about expectations, dollar support and also trying to encourage the resumption of CB flows into Treasuries. Do keep in mind that the Fed has things like the TIC flows and custodial balances way before the public sees them, and that they are by necessity a short term oriented institution.
Also note as an aside that per the Humphrey Hawkins Act, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.
Finster
06-20-07, 05:57 PM
I maintain that the Fed has been "managing" rates since the '40s for all sorts of different reasons and purposes. SecLend is just one of the more recent methods they use.
You asked the right question too. In my opinion, the recent SecLend operation was all about expectations, dollar support and also trying to encourage the resumption of CB flows into Treasuries. Do keep in mind that the Fed has things like the TIC flows and custodial balances way before the public sees them, and that they are by necessity a short term oriented institution.
Also note as an aside that per the Humphrey Hawkins Act, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.
For that matter, the Fed has been managing rates in one form or another since birth. Unfortunately, its results have been about in line with most other attempts at economic central planning.
So far as this commentator is concerned, the larger the scope of Fed operations, the worse off we are.
Now we have altogether tooo much agreement goin' on here. ;) But your last few posts have been especially illuminating; thanks for the great thread.
I may never fully get my arms around these Fed ops, so am grateful that you are here to help keep tabs on them for us.
Can we try to put together a big picture, at least for the near term? How would you characterize the inflationary environment? Does it appear to you the Fed is actually getting serious about reigning in inflation? As you know, I have been very skeptical, but a great deal of that skepticism has to do with just one fact - the tendency to focus on so-called "core" inflation. As long as the Fed is in denial about how high inflation has actually been running, it's hard to take its inflation-fighting rhetoric seriously. On the other hand, if indeed the Fed is actually trying to pressure rates higher even at the long end of the curve, it is not beyond the pale of reason that it is actually backing its words up with action, however feeble. And for sure, in our highly leveraged economy, it may not even take all that much to tip the balance in the other direction. They must be aware of that.
One thing the Fed may not be consciously aware of, however, is that much of its policy stance has actually been a depressant on longer rates. Sheer predictability on the short-term front encourages leverage and risk-taking on the longer end. If it is actively trying to nudge long rates northward, it is either acting at cross-purposes with itself or in fact its policy is in flux.
And while we're at it, what inplications do you see for portfolio management? Near term, would you favor more or less stocks, more or less bonds, more or less cash, more or less hard money, etc?
So far as this commentator is concerned, the larger the scope of Fed operations, the worse off we are.
You're anything but common... :eek: :rolleyes:
Now we have altogether tooo much agreement goin' on here. ;)
:p :p :p :p :p :p :p
Take that then!
But your last few posts have been especially illuminating; thanks for the great thread.
I may never fully get my arms around these Fed ops, so am grateful that you are here to help keep tabs on them for us.
Probably my toughest task is to try and make the research I do truly and broadly understandable. Feedback like yours and a very few others helps greatly to know what needs to be clarified... and there's also the little matter of available time in and amongst life and other taskoids. I hope to produce an article soon on SecLend and this thread helps.
Can we try to put together a big picture, at least for the near term? How would you characterize the inflationary environment? Does it appear to you the Fed is actually getting serious about reigning in inflation? As you know, I have been very skeptical, but a great deal of that skepticism has to do with just one fact - the tendency to focus on so-called "core" inflation. As long as the Fed is in denial about how high inflation has actually been running, it's hard to take its inflation-fighting rhetoric seriously. On the other hand, if indeed the Fed is actually trying to pressure rates higher even at the long end of the curve, it is not beyond the pale of reason that it is actually backing its words up with action, however feeble. And for sure, in our highly leveraged economy, it may not even take all that much to tip the balance in the other direction. They must be aware of that.
One thing the Fed may not be consciously aware of, however, is that much of its policy stance has actually been a depressant on longer rates. Sheer predictability on the short-term front encourages leverage and risk-taking on the longer end. If it is actively trying to nudge long rates northward, it is either acting at cross-purposes with itself or in fact its policy is in flux.
And while we're at it, what implications do you see for portfolio management? Near term, would you favor more or less stocks, more or less bonds, more or less cash, more or less hard money, etc?
Yoiks... very tall order, especially about the portfolio management area given that I'm more of a short term trader than ever before.
As far as the inflationary environment and whether the Fed is actually getting serious about reigning in inflation - the straight answer is that there are minor signs that they are, and they're the same ones you're aware of. There'll be quite a lag until they impact the economy (4-8 months minimum) though and it doesn't look from here like they'll be very large either.
The worse news though is that they've been on the gas pedal in other and more general areas too, so the respite will be pretty short... and that and $4 will buy you a nice latte. In other words, I do much better on the short term than on the intermediate or long term.
Another way to look at it is that the recent SecLend pressure is only a short term action... and by virtue of the sensitivity of our massively leveraged economy, the Fed is forced into baby steps except for emergencies. Do recall too that they're well aware that the large BoJ change in monetary base last year is considered as the trigger for the worldwide stock drop, and also recall that the Fed raised the discount rate a full 1% in August of 1929 and you know what happened after that.
I sure don't envy Bernanke and the FOMC for the razor's edge they're trying to walk. It's a matter of when, where and how deep they'll get cut... and how much and how fast they can apply the correct antibiotics. It hasn't been a matter of "if" for years.
Internally, I'm pretty sure they know close to exactly what's going on with inflation and Bernanke is being pretty straight about "inflation risks" although in Fed Speak that actually means public awareness of inflation.
One thing you may want to look at on Fed predictability and its actual policy stance are it's three actual mandated goals & purposes per Humphrey/Hawkins (aka "The Monetary Control Act of 1980" if memory serves)... and that they can only hit 2 out of 3 at best in our relatively mature economy.
1. "full" employment
2. "low" interest rates
3. "price" stability (includes the value of the dollar)
... plus also keeping in mind they're owned by bankers and have that vested interest. It has helped me to put what they're actually doing (by far the most important) and what they're saying into a better perspective.
As far as portfolio balance, etc., my crystal ball is still as cloudy as ever and it seldom goes out more than a few days to weeks.
The long term hard or real asset bull is alive & well, US inflation is very unlikely to go negative, "ka" is still ahead, stocks will be supported as well as the Fed & Treasury can pull off (and real bearish sentiment will always beat them like it did in 2000-2001, etc.)(and today's action is troubling given that we're in the middle of a TIO operation with a TIO + TOMO pool balance of about $62 billion).
All of my charts show the next 30-45 days as unusually critical. PMs appear to be bottoming, the dollar has downside ahead and could crack from 2-10%, recession is virtually assured, foreign stocks & bonds look way better than US ones and right now I'm about 75% cash. My cash position is deceptive though since tomorrow I could jump in to some leveraged trade or trades and be -400% cash or more.
Finster
06-21-07, 11:59 AM
You're anything but common... ... Yoiks... very tall order, especially about the portfolio management area given that I'm more of a short term trader than ever before....
Thanks much! Since the question was about the "near term", your reply was on point. No matter what your investment time frame, you can benefit from examining others. The short termer would like to know whether he is going against the larger trend so he can tell how urgent it is to reverse a position. The long termer would like to know when the most opportune time is to make a portfolio shift.
thanks Bart.
I don't see how it could be true that the CBs don't matter when it comes to money creation. I don't know how non-banks can create money...
You might want to look at Doug Noland's commentaries on www.prudentbear.com. He has pointed out exactly how the GSEs and Wall Street can add huge amounts of liquidity into the system. Anyone interested in the topic should take a look at his archives and read carefully.
metalman
02-24-08, 09:02 PM
You might want to look at Doug Noland's commentaries on www.prudentbear.com (http://www.prudentbear.com). He has pointed out exactly how the GSEs and Wall Street can add huge amounts of liquidity into the system. Anyone interested in the topic should take a look at his archives and read carefully.
even greenspan says...
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Finster
02-29-08, 10:56 AM
You might want to look at Doug Noland's commentaries on www.prudentbear.com. He has pointed out exactly how the GSEs and Wall Street can add huge amounts of liquidity into the system. Anyone interested in the topic should take a look at his archives and read carefully.
Absolutely. Noland has been right on the money (pun intended) for years, documenting the credit bubble with his curiously named Credit Bubble Bulletin. Anyone tempted to think the problems we have just materialized out of nowhere when "subprime" hit the news needs to visit those archives. This one, Coin In the Fuse Box, from September 20, 1999, is a great place to start. What's more, they put the lie to official claims that no one could see this coming. In fact, guys like Doug Noland and of course our own Eric Janszen here at iTulip were warning of such ill omens way back when the reckless policies that caused them were being pursued.
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