A Curious POMO Today Worth Commenting On.

In the current and thus far final QE (QE2) there are only 12 POMO operations left and for our newer members, a brief explanation is in order.

Bernanke straight up lied to Congress when he said the FED "Will not monetize the debt", POMO (Permanent Open Market Operations) have been the underpinning of most of the 2009 -2011 rally. Since the Federal Reserve cannot buy Treasuries directly from the treasury department, they've relied on an agreement with the Primary dealers such as Goldman Sachs and about 40 others. These primary dealers buy treasuries at Treasury auctions, hold them for a few weeks to a few months and simply flip them to the Fed during POMO. In return, the Primary dealers have collected very handsome fees from the Fed for holding these treasuries for a short period of time (with almost no risk) and have used those profits to bid up risk assets like the stock market and commodities-and that's about all that has kept this rally alive and that is why the rally is going from "The trend is your friend" to the part when the "trend starts to bend at the end". The PDs have made hundreds of millions, probably more like billions of dollars through their flipping treasuries to the Fed. This has created an artificial demand for treasuries and allowed the government to sell its debt, with the end buyer being the Federal reserve, thus monetizing the debt. However, with QE slated to end this month, the PDs may be holding more treasuries then they can effectively offload in the remaining $51 Billion of monetization.

Today's POMO showed this panic as the submitted to accepted ratio came in at a staggeringly high 8.9x, meaning the PD's offered up $28.4 Billion in Treasuries and the Fed only bought $3.2 billion. This submitted to accepted ratio is much higher then the average running a little higher then 3x and is the highest submitted to accepted ratio in all of QE2.

The end effect may be the Primary Dealers end up holding treasuries they never expected to be stuck with. The implications of that could go in several directions, but one direction would be the PD's short of cash die to having it tied up in treasuries they can't unload before QE2 ends, may have to resort to selling other assets to raise cash, It may also cause a fire sale in the short end of the curve where they have the most exposure.

One thing is for sure, today's operation was no where near normal and wreaked of panic on the part of the PDs. This could have material effect on the market moving forward if the PD's need to raise cash.