It seems that every time the market rallies seemingly "without explanation" that people start talking about this mythical "Plunge Protection Team" (otherwise known as "The President's Working Group") - a group that
does exist - as the cause.
Folks, let's dispense with the stupid first - what do
you think the odds are of some mythical working group inside the government that manipulates the stock market, slings around billions of dollars to do so, and leaves nary a trace - and yet nobody ever manages to get their hands on one scintella of evidence in the form of a trade confirmation, funds trace, or other piece of evidence that would prove this, and get it to some intrepid blogger (say, for example, me)?
This group would encompass hundreds if not thousands of people with "actual knowledge" too - yet there has been no authoritative leak (with said evidence) since Ronald Reagan's term.
Oh, and this very same government can't manage to hide a cum-stained dress.
Yeah.
Ok.
I believe in Santa Claus and the Easter Bunny too.
So.
Are there times when "excess liquidity" finds itself into the market, and all of a sudden the stock market takes off like a rocket ship - sorta like today?
Yes.
But I thought I just said there was no grand conspiracy?
That's correct - I said that.
This "conspiracy" is nothing of the kind and its hidden in plain sight.
There's even a web site to make it easy for you - it pulls the data from
another public web site, over at the New York Federal Reserve Bank. Its called "
The Slosh Report".
To understand all this - and to make sense out of both
The Petition and
The Video, you need to understand how "slosh" works, and how The Fed and interest rates actually work.
I'm going to
try to educate you.
Let's hope it works.
The Federal Reserve does not set interest rates. They can't. The market sets interest rates.
The Federal Reserve sets a TARGET for overnight borrowing between banks. The only
direct borrowing that goes on from The Fed is done at the "Discount Window", and is at a
penalty to the open market - so unless you really need to, you don't use that option.
So how does The Fed control rates?
They either add or withdraw money in exchange for securities (typically treasury bonds, but any marketable securities can and sometimes are taken in exchange.) These operations are either temporary (known as "TOMO"s) or permanent ("POMO"s).
A temporary open market operation, as the name implies, expires. That is, if The Fed "injects" $1 billion in a TOMO, it expires (has to be paid back) at some point in the future. The time period might be as short as one day or as long as several - but they are all, in effect, short-term loans, with the time set when they're made.
Now let's recall that money is a "fungible" commodity. That is, one $1 bill has the same value as any other $1 bill - they are totally interchangeable, so long as they are legitimate (not counterfeit!) $1 bills. Likewise, a $1 Federal Reserve Note (what you have in your wallet) is "fungible" in reference to $1 in credit - when you spend $1 on your debit card, an actual federal reserve note does not change hands - $1 of "credit" does. You can walk into your bank and demand that your credit (in the form of an electronic ledger entry) be handed to you in actual federal reserve notes, and it will be - and vice-versa.
So what controls the cost of money (in the form of interest rates charged)?
Simple - supply and demand.
If there is a demand for more money than there is supply, the interest rate charged will rise. If there is more supply than demand, the interest rate will fall. The rate charged will rise or fall until it is in equilibrium with supply for the duration (in this case, overnight between banks) contemplated.
Thus, The Federal Reserve twists their
SINGLE knob to either inject or withdraw "slosh" - or excess liquidity - so as to cause the
actual interest rate charged between banks to be, as close as they can get, to the
intended (published) Federal Funds Rate. (The Treasury department has an identical knob, but they twist it rarely - The Fed twists theirs nearly on a daily basis!)
The target rate and the actual trading range (that is, actual interest charged - both high and low) for any given day is
published. You can find it right here.
Now if you look at this table (open it in a new window) you will see that The Fed is not perfect. For example, on 11/6, there was actually borrowing that happened at 2-3/4%, and at 5-1/2%. The average for that day was 4.22%, which is below (by about a quarter point) the target of 4.5%.
This sometimes gives rise to the claim that The Fed has performed a "stealth ease" or a "stealth tightening" - that is, they've allowed (on purpose!) the Effective Rate to be different than the published Target Rate. That might even be true, but it doesn't matter in this particular case.
Here's the gimmick - there was, today, 11.25 Billion in "Agency" paper accepted in a 1-day "TOMO" at the NY Fed. We do not yet know what the target rate was (The Fed is typically one day behind the market in reporting this, as obviously the borrowing happens through the day)
but assuming the Fed Funds trading rate was not over the target this was $11.25 billion in extra money that went "sloshing" around the system - today.Where do you think it went?
Well it could have gone anywhere. But do you think some of it might have gone into affiliates of some of those banks - say, into Hedge Funds? And do you think some of those funds might have bought stocks with it? They might have, eh?
Before you scream
"MANIPULATION!" let me point out that this is all done in plain sight and its perfectly legal.
There is no secret, and once someone has money (credit), what they do with it is their business, right? All they give up in return is a promise to pay a given interest rate (and perhaps they post some collateral to get a better rate than they otherwise would.)
But - there's more.
See, we frequently hear that "The Fed injected a record amount of liquidity...." from various people - including some blogs often cited on the forum.
These people are either naive or intentionally misrepresenting what is going on with these operations! Twice recently such claims were made - including on 11/8 when people were
screaming about a "record" $32.75 billion that was "injected."
There's one small problem with these claims.
THEY ARE FALSE.Remember up above when I said these operations were
TEMPORARY? That is, they have to be paid back?
Well guess what - on 11/8 $40 billion of those TOMOs
MATURED.So The Fed, on 11/8, did not
inject $32.75 billion.
In fact they withdrew $7.25 billion worth of money from the system!Now today,
they really did add $11.25 billion, and it is reasonable to assume that some part of that money went into the equity markets. In fact, it would be silly to assume otherwise, given the tape we had today.
But here's the rub -
tomorrow, all of that, plus more, matures, and unless there is more issued, liquidity will be withdrawn! Further, tomorrow we will find out if, today, the Effective Fed Funds Rate was trading somewhere near the target - in other words, whether the supply was properly balanced or if The Fed played some sort of game.
So now who's the idiot?
Did you buy this rally without knowing that The Fed threw more than $11 billion on the table to be used for "whatever", but that it had to be paid back tomorrow? If you did indeed buy stocks today, without this knowledge being a part of your computation as to whether today was indeed a "good day to buy", then
you are at least somewhat likely to get a nasty surprise in the near future when that liquidity is withdrawn - perhaps as early as tomorrow!Now there are a couple of possibilities that one must consider for what was a fairly sizable net addition:
- Someone, or a bunch of someones, needed a bunch of money and spiked the Effective Fed Funds Rate. This was responded to by The Fed injecting enough liquidity to meet the demand; we will see this from the EFF data tomorrow as it will show that there were trades made at materially above target (which is what would cause them to perform the injection in the first place) and, the actual average will likely be at least somewhat above the target rate. This is quite bad, when you think about it; it may indicate that some bank was in quite a bit of trouble and needed short-term capital to meet some regulatory requirement...... Is a rally reasonable if one or more banks are potentially at risk of insolvency?
- The Fed decided to spike the punch bowl for a day - but only for a day - and they will withdraw the liquor tomorrow. We will know this if the EFF prints materially BELOW the target rate. Do you buy a rally when the money used for it is going to "disappear" in the immediate future? Or is the smarter move to SELL that rally?
The first is a sign that there was some significant stress somewhere in the banking system that The Fed responded to. The latter is a sign of The Fed attempting to make a "stick save" of a market that was clearly in trouble - not that this sort of thing would hold, but as a quick "prop job" for a day, it can be effective (like a junkie, trying to do this daily quickly winds up with the Effective Fed Funds Rate at or near zero, as available credit overwhelms demand - The Fed becomes irrelevant.)
Everyone within the regulated banking system has as part of their mandate the orderly operation of the markets. You can argue over whether such an "intervention" (via clearly published and public means) is legitimate or not, regardless of whether it was to "stick save" one bank, ten banks, or simply the equity markets, but what you can't argue with is that the mandate exists - because it does.
But - whatever the cause was, the money injected today is only good for one day and has to be paid back tomorrow - in full, with interest!
So - the next time some "magical" market rally appears out of nowhere, before you scream and holler about "The PPT" go check The Slosh Report.
Then - use your brain.
BEFORE you place your trades.
