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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: teevee who wrote (100773)	8/12/2009 11:44:15 PM
From: russet	Read Replies (2) \| Respond to of 116555

caseyresearch.com The Fed and Treasury: Cat and Mouse For some time now, we have taken considerable interest in the Treasury’s extraordinary financings because, in the same way that stomach muscles are connected to the back, so are the government’s efforts to fund its rocket-shot deficits connected to the fate of the dollar. Bud Conrad, the chief economist here at Casey Research, provides some additional context to the topic. The Fed and the Treasury are starting a new phase of their relationship predicated on the Treasury needing to borrow too much money – with huge auctions almost every week now – and the Federal Reserve’s increasingly important role as a buyer of some percentage of that debt. We know that the Federal Reserve has inaugurated a policy of aggressively buying Treasury bills, agency debt, and mortgage-backed securities as part of what is often described as Quantitative Easing. The numbers are hard to absorb: $300 billion of Treasuries, $200 billion of agency debt, and $1.2 trillion of mortgage-backed securities, all between March and September. The Fed doesn’t tell us whom they buy their Treasuries from, but it seems likely to be the same big banks that serve as primary dealers buying the debt from the government. The primary dealers appear to be holding a slice of this paper for only a short term before selling it on to the Federal Reserve. The net of those transactions becomes a further monetization of the federal debt. The Fed is also buying even more mortgage-related debt. With the government now guaranteeing mortgage-backed securities, those securities are not that much more risky than actual government debt. This gives the Fed further rationale for having purchased almost $600 billion of mortgage-backed securities since March. Which brings us to a likely connection to the speed of the stock market rebound since March 2009, a rebound that has surprised many of us. At the March bottom, I was interviewed on television, but at the time failed to see any good reason for the big jump that subsequently followed. Looking through the evidence today, we can see that the Federal Reserve has purchased close to $250 billion in Treasuries, and that may have provided the liquidity needed for the big banks to turn around and dump new cash into stocks. Goldman Sachs, to provide one example, made upwards of $100 million per day on many days through its trading activities last quarter. In the chart here, I compare the surprising stock market rally to the Fed’s purchases of Treasuries. While it could be coincidence, you will notice the clear correlation. There are many other moving parts in this complex world, so this may not be a direct manipulation of the market, but I have suspicions that our stock market is far more manipulated than most people realize. As a cautionary note, many of the emergency programs of making direct loans to financial institutions are being wound down by the Federal Reserve at the same time it is focusing on direct purchases in these specific markets. Those countervailing actions have kept the total balance sheet of the Federal Reserve relatively stable since it doubled in the second half of 2008, but that could quickly change if the Fed wanted to launch new programs. So, a key point to watch in today’s FOMC meeting is whether they indicate if they will be continuing the Quantitative Easing programs beyond the current September 30 expiration date. Many think the Fed is ready to stop, and they may not make an announcement this early, but it is probably more important to watch for this decision than their other pronouncements. This is just a glimpse at the evolving relationship between the Fed and the Treasury. Many of their actions occur out of sight. For example, in the current edition of The Casey Report, I describe how the Federal Reserve’s $500 billion swaps with foreign central banks in the latter part of 2008 probably provided those central banks the liquidity to help absorb our government Treasury issues. David has often said that the government is ready and willing to do “whatever it takes,” no matter how extreme, to try and reinflate the deflating bubble. I can see no reason to argue with that contention.