http://soberlook.com/2012/06/what-to-expect-from-fomc-tomorrow.html

( while it may not be what market junkies crave , I think Ben only " Twists " today. )

What to expect from the FOMC tomorrow

There has been some confusion about the potential policy actions the Fed could undertake at the next meeting. This is what we could expect from the FOMC tomorrow as well as the corresponding market reactions:

It is highly likely the committee will announce an easing action of some sort.
The policy decision will probably involve extended guidance, projecting fed funds rate to be near zero for longer than in previous guidance announcements. Once again, this is not a commitment, only guidance.
The Fed will also likely announce some form of a securities purchase program. The purchases would take one of the three forms:

1. Extension of Operation Twist. This is the easiest form of policy change for the Fed to implement since the program is already in place. The problem is that the Fed has only some $175bn of short tenor securities to sell (in order to buy the same amount of longer tenor bonds), which would take it to September. That may be enough however as the FOMC agrees to revisit the situation then ("kick the can" policy). Market reaction: If this were the only policy move, risk assets would sell off.

2. Sterilized purchases. The Fed would use 1-4 week reverse repo to avoid increasing bank excess reserves (avoid "printing money") . An alternative or a complement to using reverse repo is for the Fed to accept term deposits which would also reduce reserves. The one criticism of this program is that it could putupward pressure on 1-4 week rates because the Fed would be constantly in the market borrowing short term money. But this is generally viewed as an acceptable risk.

As discussed before, this program is likely to involve MBS purchases for a couple of reasons. MBS yields have a bit more room for compression than treasuries do. Also focusing on "helping" the housing market would be politically more palatable for the Fed than being seen as funding the federal budget deficit.

Market reaction: Depends on the size. $400-$600bn would be a positive for risk assets 3. Unsterilized (outright) securities purchases, otherwise known as Quantitative Easing (QE3). Securities purchases would be funded by increasing the bank excess reserves ("money printing"). As discussed before, this scenario is unlikely because it would be kept as a "weapon of last resort". It would be employed in an absolute crisis situation, such as a major sovereign default in the Eurozone or an Iran induced global oil disruption. QE is also highly unpopular and the Fed is not impervious to popular opinion. Given the current expansion of credit in the US, QE would be difficult to justify.

Market reaction: Risk assets would rally (obviously depending on what else is going on globally)

All of these programs will have only a limited effect on the US economy. Even MBS purchases, the best option out there, are not expected to yield tremendous results in generating growth and jobs. A 30-year mortgage at 2% will put some cash in people's pockets for those who can refinance. But it's not going to improve the credit score for those who can not refinance or do not qualify for a mortgage. And the 10-year treasury at half its current yield (which is what Japan has) is hardly going to help improve economic activity. But the Fed promised to stay vigilant, and given the limited toolbox, these policy moves may be the best the central bank will be able to accomplish on its own.

http://ftalphaville.ft.com/blog/2012/06/19/1049671/problems-with-extending-twist-and-one-final-preview/

( Can the Fed even run a successful twist though ? )

Problems with extending Twist, and one final preview

Posted by Cardiff Garcia on Jun 19 21:13.

Supply and liquidity, to name two obstacles for an extension of the Fed’s policy of selling short-end Treasuries and buying long-dated ones.

Doesn’t mean they’re insurmountable, only that it will be a little more complicated this time should the US central bank take this route.

If you want to skip the details below, here’s the summary from strategists at SocGen and RBC:

1) The Fed has a dwindling supply of short-end Treasuries to offload. Selling longer-maturity Treasuries would risk diluting the impact of the Twist, raising rates closer to the part of the curve where they’re trying to keep them low.

2) Liquidity in recent auctions to sell the Treasuries that the Fed has been buying has been abnormally low.

Here is SocGen (emphasis ours in all cases):

While it may be tempting to assume that the Fed will simply extend the MEP program, we do not see this as the most likely option. We estimate that at the end of June, the SOMA portfolio will hold between $150bn and $175bn of Treasury paper with maturities <3 years, the kind that the Fed is selling as part of Operation Twist.

There is therefore limited scope for a Twist 2, unless the Fed decides to sell 3y-5y paper and shift its purchases further along the curve. This, however, would likely be counterproductive as it may put upward pressure on the section of the curve which drives most borrowing rates for businesses and consumers.

And here is RBC:

In two consecutive Fed purchases within the 8 to 10y sector, offer-to-cover has come in below 1.9x, which suggests liquidity is extremely poor. Perhaps more importantly, it was below the level (1.98x) seen in the 20y to 30y sector that preceded the Fed’s decision to shift from five $2.6bn 20y to 30y purchases per month to seven $1.8bn purchases—effectively those low offers made the Fed determine that liquidity had become so poor that the market could not handle a $2.6bn operation.

The plunge in 8y to 10y offers suggests that it would be too risky for the Fed to continue 8y to 10y purchases in the $5bn size. The Fed would need either to shrink the monthly rate of purchases or to reduce the maturity of its purchases sharply to move into more liquid parts of the curve if it were to extend Twist. This is one of several reasons that we believe Twist will end on schedule in June.

————

Meanwhile, Credit Suisse has similar estimates for the amount of Treasuries the Fed can sell of less than three maturities, but doesn’t think it’s too much of a problem to sell more in the 3-4.5-year range — and anticipates that they’ll combine selling in this range with purchasing a mix of Treasuries and Agency MBS. Buying the latter would have the benefit of both mitigating the liquidity problem and targeting the housing market:

Of the $350 billion in SOMA holdings that we identify as likely to be sold, based on the assumption that the Fed will again target to sell just 75% of total holdings within the maturity range, over $220 billion is beyond the 3-year maturity point. This is a direct result of the fact that the first iteration of Twist liquidated the majority of the Fed’s holdings maturing within 3 years. But it should result in a much more concentrated impact at the front end of the curve, both because rates 3 years and in already cheapened through the first Twist operation and because the 3- to 4.5-year area of the curve would absorb more than 60% of the sales in an extension. ….

Markets already appear to be pricing in an extended Twist, which shouldn’t be too surprising given the weakening economic data recently. But some markets are pricing in Twist specifically rather than just a general expectation of further easing — back to Credit Suisse:

Market pricing for the “Twist” extension has resulted in relative cheapening in three-year Treasuries and in turn relatively tight three-year swap spreads. Exhibit 5 shows that based on the past six-month regression, three-year swap spreads appear to be approximately 4bp too tight relative to the 3rd IMM FRA/OIS spread.

All the same, we’ve seen a lot of guesses for what the Fed might do tomorrow (here’sone roundup) and posted a couple of them last week, but the truth is that the range of possible and realistic outcomes for this meetings is unusually wide.

So to recap, and without playing percentages too much, here again are the Fed’s options and some of their complicating factors (not mutually exclusive):

1) Extend Twist

– Perhaps for only a few months rather than through the end of the year

– Possibly combine sales of short-end Treasuries with purchases of Agency MBS along with Treasuries

2) Quantitative Easing via outright expansion of its balance sheet

– How much: we’ve estimates all over the place, up to $600bn

– Composition: Treasuries vs Agency MBS

3) Change the “rates exceptionally low” language in the statement, push back to 2015

– Could create further confusion depending on how the individual forecasts of the FOMC members shift

– Might also just change the language to be more dove-ish generally

4) Telegraph future easing through changes in the statement (thanks to Robin Harding for reminding us of this possibility)

– Emphasise here again that this could be done in combination with one or more of the other options

All of the above are real possibilities. The next few are less likely but can’t be ruled out entirely. …

6) Cut the interest on excess reserves

– Doubtful, as the Fed likely believes that this is crucial for orderly functioning of money markets, which are having enough problems as it is

7a) Cut the discount rate (now at 0.75 per cent), aka the primary credit rate that American banks have to pay if they tap the Fed’s discount window

7b) Lower the swap rate for foreign central banks

– Meh.

Long shot: introduce an improvement to its new communications approach (see Robin’s post from April for some ideas, and ours for why it might help)

– We haven’t seen this possibility reported or discussed much lately, so we really doubt it.

9) Even longer shot: Make it clear that the Fed would tolerate a period of higher-than-target inflation until unemployment declines further

– Note that this is different from temporarily raising the inflation target, which stays the same: indeed keeping the 2 per cent target would (in theory) help to keep inflation and inflation expectations from running away during the temporary period of catchup inflation. Bernanke actually might have leaned in that direction at the last presser more than we’d initially realised (minus the “make it clear” part).

– Greg Ip had a good piece on Monday about this, and the NGDP targeting wonks among you might enjoy these recent excerpts from Lars Svensson.

This entry was posted by Cardiff Garcia on Tuesday, June 19th, 2012 at 21:13 and is filed under Capital markets. Tagged with FOMC, FOMC preview, Operation Twist.

and.....

http://www.zerohedge.com/news/frontrunning-qe-did-market-make-qe-impossible

By Frontrunning QE, Did The Market Make QE Impossible?

Submitted by Tyler Durden on 06/19/2012 17:09 -0400

Bond

Deutsche Bank

European Central Bank

Ever since the beginning of the year we have been saying that in order for the Fed to unleash QE, stocks have to drop by 20-30%to give political cover to the Fed (and/or ECB) to engage in another round of wanton currency destruction. Because while on one hand the temptation to boost stocks is so very high in an election year, the threat to one's presidential re-election chances that soaring gas prices late into the summer does, is simply far too big to be ignored. Yet here we are: stocks are just 4% off their 2012 highs, even as bonds are near all time low yields, and mortgages are at their all time lows. As such, even with the latest batch of economic data coming in simply atrocious, the Fed finds itself in a Catch 22 - it wants to help the stock market hoping that in itself will boost the "economy", yet it knows what more QE here will do to the priced of gold and inflation expectations: something which as Hilsenrath himself said yesterday does not compute, as it runs against everything "Economic textbooks" teach. What is more important, is that the market, like a true addict, is oblivious to any of these considerations, and has priced in a massive bout of Quantitative Easing to be announced tomorrow at 2:15 pm. There is one problem though: has the market, by pricing in QE on every down day - the onlybuying catalyst in the past month have been hopes of more QE - made QE impossible? Observe the following chart from SocGen which shows 6 month forward equity vol. What is obvious is that due to precisely being priced in, QE is now virtually unfeasible, irrelevant of what Goldman and its "FLOW QE" model tell us. As SocGen simply states: "More stress is needed to trigger ample policy response."

Naturally, SocGen is not the first to get this. Recall that this is precisely the logical espoused by both Citi a month ago which warned of XO crossing above 1000 bps first, and then Deutsche Bank this weekendsaying a crash may well be needed to jar Europe out of inactivity like last fall. Not to Goldman though. Goldman is confident that the 4% drop in the S&P from its highs is enough to unleash an epic episode of monetization. Well, the chart below begs to differ.

Of course, if Goldman is right, and the Fed does indeed go ahead and launch some version of a Flow-based easing program, with a $50-$75 billion monthly monetization total, then kiss it all goodbye, as going forward the market will consider even a one tick drop in the ES a sufficient reason to kill the USD, and buy every ounce of physical gold available. In the process, of course, the Weimar wheels will start turning.

Furthermore, while stocks are always in their little world, and always, absolutely always wrong in the long-run, recall that the fixed income markets are saying something totally different: no bombastic LSAP program, but a very timid Op Twist expansion, where the 3 year selling threshold is extended by one year to include 4 year bond sales. An outcome such as this will send stocks plunging as it is merely more sterilized easing - the kind of intervention that has had no real impact on risk at all as all risk gains in the past 9 months have came solely from Europe's $1.3 trillion LTRO-based balance sheet expansion.

So what will it be? More QE, whereby the Fed admits defeat and hands over the monetary apparatus to an increasingly more petulant market, or no QE, and a wholesale risk crash in one day.

Tune in tomorrow at 2:15 pm to find out.

http://www.zerohedge.com/news/hope-bernanke-ex-machina-drive-low-volume-equity-surge-gold-defies-qe-dream

Hope Of Bernanke Ex Machina Drives Low Volume Equity Surge As Gold Defies QE Dream

Submitted by Tyler Durden on 06/19/2012 16:27 -0400

S&P 500 e-mini futures managed to get back above their 50DMA, fill the gap back to the 5/4 ugly-NFP print levels, and retrace 61.8% of the recent swing high-to-low ahead of tomorrow's hope-laden FOMC-print-fest. As we noted here, credit markets do not agree that QE is coming anytime soon and today's Gold deterioration suggests expectations for anything more than a twist extension are overblown (which we suspect would be a huge disappointment to a market only 4% off its highs and a VIX with a 17 handle earlier in the day. As the afternoon wore on and the incredible reporting falsehoods were denied, equity markets (and EUR) reverted lower (led by financials) pulling back to VWAP (and VIX pushed back rapidly to 18.5 - ending the day higher in vol (despite a 10pt jump in the S&P). Low volume and falling average trade size suggests this was far from the start of a new trend in stocks and the push higher (and steeper) in TSY yields to Monday's opening highs seems more like QE hope fading than growth hope. Silver just underperformed Gold on the day (both leaking lower) as Oil and Copper rallied (leaving WTI in the green for the week) as USD weakened and round-tripped to Monday's opening lows (with AUD now 1.3% stronger on the week). Investment grade credit remains a considerable underperformer relative to the high beta equity and high yield markets but 'agrees' with Gold and Treasuries in its view of no LSAP tomorrow- and the surge in implied correlation into the close suggests macro overlays as opposed to a market with any conviction.

IG credit remains a notable underperformer from the 5/4 NFP print trade but high-beta credit and equity have reverted perfectly.Note tomorrow is CDS roll day and credit index options expiry which likely explains some of the squeeze today - with credit in the middle of the recent cycle meaning plenty of to-and-fro in risk...

But gold and Treasuries appear to have faded the QE hope today (as TSYs gave up their hope-gains and gold faded today)...

ES closed rather weakly - ending the day just shy of Monday's opening highs and at today's VWAP...

It would appear AUDJPY has been the whipping boy for powering ES higher as we see quite a significant divergence between AUD's 1.33% gain this week relative to USD's 'average' 0.25% loss. If we are disappointed tomorrow, we suspect AUD will get crushed...

Correlations between equities and broad risk assets faded significantly as stocks surged but increased notably as the late day weakness arrived. Most notably though into the last hour of the day was the surge in implied correlation (think systemic/crash risk) and disconnect between a higher VIX and higher stocks...

Most of the major financials gains were in the first 30 minutes of today and after that they were flat to sideways as we suspect the shorts were squeezed out in a hurry on some technical crosses.