Securities Lending, Fed Watching Part Deux
a.k.a., everybody knows you can't predict the future, part deuxNovember 28, 2005Print
In a prior article, a predictive chart for the Dow Jones average was shared. The London bombings occurred the day before it was published which were followed somewhat closely by Katrina & Rita � so much for predictions that go awry in spite of best efforts due to unexpected and unpredictable events. Back to that later since some very odd and interesting data showed up while surfing around on the site of the New York Fed.
I ran into something called Securities Lending and here's the definition straight from the Fed�s page:
"The Bank provides a secondary and temporary source of securities to the Treasury financing market through a Securities Lending program to promote smooth clearing of Treasury securities. The program offers securities for loan from the System Open Market Account (SOMA) portfolio in accordance with program terms and conditions. Securities loans are awarded to primary dealers based on competitive bidding in an auction held each business day at noon eastern standard time."
Elsewhere (about 90% through), its defined as "a secondary and temporary source of securities in the Treasury market".
Basically, it’s primary and official function seems to be to help smooth the operation of the Treasury bond and Treasury bill markets and was very helpful for example after 9/11 in helping to stabilize those markets. Here's the data up through September 2005 and one can easily see the massive efforts of the Fed to provide needed liquidity after 9/11 as well as the growth of securities lending to a net total above a trillion dollars:
“Cumulative securities lending” was calculated by taking the weekly total of securities lent and then subtracting the value of the ones maturing that week. For example, let's say that the Fed lent $10 billion during the week of January 2004 and it was all in a bond that matured in the second week of July 2005. Also assume that the Fed lent out an additional $5 billion during the second week of July 2004. The resulting net securities lent would be minus $5 billion since the $10 billion lent in 2004 matured and could no longer be lent.
But, there has recently been a huge change in the Securities Lending operation and it appears that the change was date coincident with a meeting at the NY Fed in mid September with representatives of major banks. To the best of my knowledge, the Fed has not commented on this extraordinarily large change. Over one trillion dollars worth of Treasury bond and Treasury bills have been removed from the securities lending program since the meeting at the New York Fed in September.
What does it mean?
As noted above, the Fed has not announced anything about this change nor about what the meeting covered. Does the Fed believe that liquidity is in such good shape that they have removed the trillion dollars from their lending program? Conjecture and guessing is all that's left, and caution is urged on jumping to any conclusions. It's just one more data point to be used in evaluating one�s market position and outlook, but it sure isn't a small effect. In my opinion, it sure does seem like some type of deal was reached and was hopefully related to handling some of the �naked short selling�1 and other less than ethical issues that have been mentioned by Jim Puplava and others, but holding one�s breath is not recommended. I also have more than a few questions about what the various banks were doing with those trillion dollars of Treasury securities during this year, and the word manipulation has occurred to me maybe once or even twice� but facts are scarce and I don't know.
Dow Jones prediction
First, an apology � a mistake was made and there was an error in our forecast model from which our original prediction was created in 2004. The factor for monetary velocity2, while present, was simply missing in the final equation. Any other changes in the graph from the one published in July are simply due to corrections in the underlying data made by the Fed and other data sources. Do note that Securities Lending is not a factor in the predictive chart below.
See the previous article for more detail on how the predictive chart was developed and most of the logic behind it, as well as some warnings.
M3, Repos and Fed transparency
Just in case there may be some doubt still remaining on how important it is that the Fed will be dropping repos3 along with M34 reporting next March, please note the high correlation between the Dow Jones average and repos after a 41 week time lag is applied (to allow newly created money to flow into the system). The only change to the raw repo data was to multiply it by a constant to bring it up to the same range as the Dow.
If repos are not important, is this very high correlation just coincidence?
- Naked short selling - A naked short is one in which a stock broker does not find the stock shares to borrow within the legal time limit and is also known as a �failure to deliver� Naked short selling can threaten the stability of stock prices because stocks can be sold without having to first acquire them from existing owners. There is much more at Wikipedia, from which this definition was extracted and simplified.
- Velocity - a measure of how fast money moves through the economy. As extreme examples, velocity was small during the Great Depression and quite large in the late ’70s high inflation period.
- Repos - short for repurchase agreements. Overly simplified, it’s a loan.
- M3 - the most inclusive measure of money published by the Fed. It includes everything from checking and savings accounts through money market funds and CDs over $100,000 in value.
© 2005 Bart