Last October we penned a post pointing to the failed policy of the Federal Reserve through Operation Twist. We noted that since the first day of long bond purchases under Bernanke, interest rates have done nothing but rise, despite the intention of the operation to have them fall.
The reason of course for the rise in rates was because big banks, institutional asset managers, and primary dealers bought an ocean of Treasuries, Equity traded Treasury instruments, and Treasury derivatives in front of the Fed only to sell them all back to the Fed when Bernanke commenced their purchases last October.
The following is from our previous post:
“The above chart is of an Exchange Traded Fund (ETF) that uses derivatives sponsored by Barclays PLC, a Federal Reserve primary dealer, to track and invest in longer dated Treasuries of maturities greater than twenty years. I have highlighted on the chart significant events surrounding the speculation, announcement, and implementation of the Fed’s Operation Twist programâ€¦Despite what is written in the financial press about “investors seeking safety in Treasuries pushing prices up and yields down,” in reality, it is nothing more than banks and institutions and especially primary dealers with the Federal Reserve moving money over to Treasuries — in this case to be paid off by the Fed once they begin their purchases. Why they choose to say “investors” implying you and me, I do not know.
I chose the ETF in this case to highlight also the distortions that exist and the manipulation that is possible using a derivative-backed product issued and maintained by a primary dealer of the Fed. In the three months beginning August 1 and ending October 3, this product returned 25.6 percent plus three dividends bringing the total return to 26.7 percent. A comparable index or portfolio of Treasuries over the same period would have returned around 14 or 15 percent. The largest holder of this ETF as of June 30, just before the run-up began, was Credit Suisse, another primary dealer with the Federal Reserve, which holds more than 25 percent of all shares. Clearly, as the chart shows, these banks, institutions and especially primary dealers with the Fed have successfully manipulated the market around the Fed’s actions and came away quite well.”
An update of the transactions from the SEC reveals that from October 1, 2011 through December 31, 2011, Credit Suisse sold 43 percent of those shares I highlighted above. Over the same period, Morgan Stanley, Barclays, Deutsche Bank, JP Morgan, and Goldman Sachs all sold between 24 and 60 percent of their shares. Goldman was the biggest seller. Theses six Federal Reserve Primary Dealers sold a total of 9,041,933 shares while the Fed was buying. That represents one-third of all shares outstanding.
The following table shows the respective sales:
Goldman Sachs stands out in particular relative to this group because in addition to the sales listed above, Goldman also purchased 1,971,964 shares of a product that makes money based on the falling prices of Treasuries. It’s a big bet that interest rates will rise. All of these shares were purchased between October 1, 2011 and December 31, 2011 and represent about 9 percent of all shares available. No other firm even comes close to this figure.
I’ve updated the Treasuries chart to reflect the trading that has ensued since our last post:
What’s important to notice here is that while Treasury prices have been falling since the Fed first began their purchases, they have remained at elevated prices. Indeed, yields for 10-year paper currently stand at 2.3 percent. This has everything to do with the Fed buying over $40 billion worth of long Treasuries every month since October, counterbalancing the institutional selling and mitigating the pressure from negative bets from Goldman and others.
However, this will end in June. At that time Operation Twist ends, and the Fed will no longer be buying our debt. As a result, most market participants are anticipating yields to rise precipitously this summer. Short positions, in addition to those placed by Goldman, are already being allocated to this move, and Treasury yields are beginning to trend higher. Traders are also betting that the Fed will raise interest rates a year earlier than the stated “end of 2014” date as fed funds futures markets are pricing in a quarter point rise in the November 2013 contract.
So it seems that the market has thrown a giant wrench in the monetary policy intentions of the Federal Reserve. The Fed target rate was intended to be at zero for another two-and-a-half years, and Operation Twist was to ensure that longer term borrowing rates for the United States were to remain low to allow for deficit spending to aid in the recovery a la Lord Keynes.
Instead, Goldman and a host of other institutional players scammed the Fed ahead of their purchases and are now betting against its long-term efficacy. What’s more is that the 30 percent bull-run in the S&P 500 over the past six months, which coincidentally began on the precise date of the beginning of Operation Twist, October 4th, has been largely fueled by freed-up capital from purchases by the Fed.
Without further accommodation from the Fed, there is little that can support both asset prices and the ridiculously low yields on not only Treasuries, but also corporates, munis, and junk (which are all at about half their historical average).
I guess that means QE3.
Without robust economic growth, there really is no other alternative.
Let’s hope that Bernanke is soon proven right by his efforts and the United States starts putting up 3+ percent GDP growth with stable inflation. I think we’d all prefer remembering him as our savior from economic collapse rather than Goldman Sachs’ biggest sucker.