This Isn’t a Conspiracy, It’s Simple Math

I’m going to give you series of number pairs. Don’t worry about what they are, I don’t want you to bring any biases into this. Just consider the pattern.

2, 4
4, 6.5
1, 2
4, 6.5
6.5, 30
1, 2
6.5, 30
2, 4
4, 6.5
6.5, 30
4, 6.5
1, 2
6.5, 30
2, 4
4, 6.5
1, 2
6.5, 30
4, 6.5

Is there an exact pattern? If so, I don’t see it. But we do see three obvious facts. First there is a discrete set of possible number pairs. Second, each of the pairs seem to show up with fair regularity. Third, the pairs never repeat twice in a row.

So if you had to guess, which pair would you expect next? 2, 4 right? Just because its the pair that hasn’t appeared for the longest.

Alright, new topic.

Fannie Mae issues “benchmark” bonds each month, or at least they plan to do so. These are large, non-callable issues of at least $3 billion. At one time, that might have included anything from 2, 3, 5, 10 or 30-year maturities, although I don’t believe they’ve done anything longer than 5-years in a while. Regardless, we knew Fannie would be announcing a benchmark issue on October 7th for several months. Here is a release dating to March which shows 10/7 as a benchmark issue date. For what its worth, it took me 13 seconds to find proof that Fannie was planning to issue on 10/7 for months.

Now let’s bring this home. The “pattern” above is the maturity ranges the Fed has been buying as part of its Agency buy-back program since June. Remember these buybacks are every Thursday. Have been for months. Everyone knows what day the buyback happens, we just don’t know exactly what the maturity range will be. But if you look at the pattern above, anyone with a 3rd grade education could guess that 2-4 was a very strong candidate. And by the way, the Fed basically offers to buy back any benchmark bond within that maturity band. So it would have been unusual for the Fed not to include the newly issued Fannie 2-year benchmark.

If the Fed is going to buy agency bonds every Thursday, then it was destined for months that the Fed would be doing a buyback the day after Fannie did their benchmark issuance. In fact, as long as Fannie is going to issue benchmark bonds once a month and the Fed is going to do buybacks once a week, it was inevitable that one of the buybacks would happen right around a new issuance. This isn’t a conspiracy, its simple math.

So at best, you can argue that Fannie choose to do a 2-year issue hoping that would be what the Fed was going to buy back. Or I suppose you could argue that the Fed told Fannie Mae (NYSE:FNM) which set of securities they were buying back. Gave them a heads up. Still you have to wonder of what great advantage such a heads up would be. Looking back at the pattern, if the Fed didn’t buy 2-year agency bonds this week, certainly it would be next week. Wall Street would know that.

So let’s remember the three inescapable conclusions here. As long as the Fed is going to be buying Agency debentures in already established pattern, and as long as Fannie Mae is going to be doing monthly issuance of benchmark securities, it was bound to happen that issuance and buyback would occur in very close proximity. Wall Street has been aware of both the timing of the buyback and the timing of Fannie’s new issue for months.

So why do I bring this up? Because of this post at Zero Hedge. Basically saying that the Fed’s decision to buy the newly issued Fannie bond was “blatant” monetization. The author claims to be “dumbfounded” that the fed would be so bold. The Imperial Senate will not sit still for this!

I don’t have a problem with claims that the Fed is conducting de facto monetization through its QE efforts. I don’t agree. I think Quantitative Easing is a legitimate monetary policy tool. But I readily admit that the distance between QE and monetization is no more than three meters wide. I think the Fed is still on the correct side of that line, but it is a perfectly legitimate and important public policy debate. I’m open minded to the possibility that the Fed could cross that line at some point. I welcome rational and objective discussion aimed at convincing me and others that the line has already been crossed.

To be fair, I don’t read Zero Hedge, so I am loathe to generalize about the opinions held on that site. However its obvious that the author is of the opinion that the Fed has crossed the line. Fine. Let’s hear the case. But instead, Zero Hedge tries to link this particular buy back with debt monetization, when I’ve clearly shown above that this particular buy back doesn’t indicate anything either way. Zero Hedge is presenting non-evidence as evidence.

So one of two things must be going on. Either Zero Hedge is ignorant of all the above facts, or he’s intentionally ignoring the facts to make his argument more sensationalist.

And that’s is what is so incredibly frustrating. We can’t have rational debate in America any more. No one wants to coldly and objectively discuss facts. Reasonable minds can differ. I’ve looked at the factual evidence, used my economic training and my bond trading experience and concluded that what the Fed is doing doesn’t amount to monetization. Someone else could look at the same evidence and come to a different conclusion. Wouldn’t it be nice if the blogosphere was full of people explaining their point of view using objective facts in the spirit of reasoned debate?

But that doesn’t happen, because that doesn’t generate hits. To generate hits you need to be sensationalist. Everything has to be a conspiracy or a pending disaster. And no one gives a gundar’s ear about credibility. So why should a blogger bother checking facts? Why bother asking a bond trader about how these agency buy backs work, just to make sure your first read of the situation is correct? No. Better to just run with the piece assuming conspiracy because your readers will assume credibility. As of this writing, Zero Hedge’s post on the agency buyback has generated over 2,000 hits. A quick Google search reveals at least 13 websites linking to the Zero Hedge piece. At a glance all are supportive of Zero Hedge’s position. No one questions anything.

And that’s a summary of just about every debate here in America. Both sides feel the need to sensationalize their argument, facts be damned. So the debate devolves into an argument about facts rather than a debate on the merits of an argument. The left says x millions of Americans don’t have health insurance. The right says no! Its more like a much smaller y millions. And around and around we go throwing out massaged number after massaged number, never actually getting to discuss the real issue of whether government should be providing health care.

Let me be very clear. Even if you the Fed was trying to monetize the Federal debt, this particular agency buy back shouldn’t strengthen that view. The Fed is conducting its agency buy back program the same way it always has. Fannie Mae is conducting its debt issuance the same way it always has. No matter what your view, this is a non-event. Don’t write me a bunch of e-mails saying that I don’t get it. I understand the monetization argument. I really do. This particular fact has nothing to do with anything.

By presenting this non-evidence as evidence, Zero Hedge is only succeeding in being inflammatory. He’s riling up people who already feel a certain way. That kind of thing makes any hope of a rational debate fade. There are those that hail the internet as this sort of modern day salon. Where any voice can be heard, creating a Renaissance of intelligent thought. Sadly I think its just the opposite.

About Accrued Interest 118 Articles

Accrued Interest provides unique, expert insight to developments in the U.S. bond market. It is written by an anonymous professional working in the field.

Visit: Accrued Interest

Be the first to comment

Leave a Reply

Your email address will not be published.


*