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Post# of 704019
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Joe Stocks

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Joe Stocks

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Re: Public Heel post# 44388

Tuesday, 11/12/2002 11:04:32 AM

Tuesday, November 12, 2002 11:04:32 AM

Post# of 704019
>>particularly on the Repo matter<<

Maybe this will help.

>>The staff of the New York Fed's Trading Desk continuously
monitors global financial conditions and the state of banking
reserves each day. After extensive deliberation beginning early
each morning and a conference call with all of the regional feds,
it determines whether or not it will add to, drain from, or leave
unchanged the level of banking reserves. This is carried out on
a daily basis. A plan of action is established for the day, and
the Fed executes it by moving huge amounts of money through its
network of 22 primary dealers, which are banks and securities
brokerages that deal in US government securities. To give you an
idea of the money flows being executed, these 22 dealers averaged
$375B per day in trading volume of US government securities in
March, 2002, according to the New York Fed website.

The most frequent transactions are called "repurchase agreements"
or repos (RP) for short, which are described as short term
transactions whereby the Fed purchases securities from the
dealers, who agree to repurchase them from the Fed by a specified
date at the specified price. When the repos mature, the added
reserves are automatically drained. The Fed pays for the
securities and takes delivery thereof simultaneously. When they
mature, often the next day as we've seen in the Market Monitor
(known as "overnight repos"), the securities are returned and the
funds reimbursed by the dealers to the Fed.

The reverse of a repo is called a matched sale-purchase
transactions (MSP's), whereby securities are sold to the dealers
for cash, and then repurchased from the dealers upon maturity.

Both Repos (RP's) and matched sale-purchase transactions (MSP's)
are temporary open market operations. Sometimes the Fed will
sell securities to or purchase securities from the dealers
outright, which affects the dealers' reserves on a permanent
basis.

If you're all still awake, or haven't yet dashed off to apply for
jobs with the Fed, here's the kicker. The effect of these OMO's
on the 22 dealers' reserves has a direct influence on the level
of liquidity in the markets, just as we saw in Livermore's 1907
example. When the dealers have excess reserves, they are free to
play with those funds until such time as the funds must be
returned. This liquidity finds its way into the markets,
purchasing securities. On days when reserves are drained, the
liquidity finds its way out of the market. During the past
months, there has been a tendency to see market strength on days
when large repos of 5-10B have been announced. When these repos
expire, if they are not replaced with new repos, we often see
market weakness. This year, because we are in the grip of a bear
market, the tendency has been to see repos. I have only seen one
instance of an MSP this year, although I've only been following
the Fed for the past few months.

The trouble for traders is in knowing which markets will be
affected by each Open Market Operation, and within each market,
which securities. Repo money can go into equities or fixed income
securities, currencies, or whatever else the dealers wish on that
day. I have read arguments to the effect that companies such as
MSFT are prime targets for Fed money because they are listed on
multiple indices, and so buying or selling in MSFT gives the
Fed's dealers the greatest bang for their buck. Remember that
the Fed's goal is to encourage the stability of financial
markets. When these markets are in jeopardy, smart traders watch
for the Fed's morning announcement and consider which markets
need it most. When the SPX broke 775 this month, an overnight
repo of $4.5B was announced, which is at the upper end of
modestly sized for repos this year, and equities bounced off
their lows, which then triggered a selloff in the extremely toppy
bond market, more money flowed into equities, and the rest we
know well. During the summer, I watched large orders that would
show up like a battalion at critical support levels on QQQ –
30,000 to 50,000 share bids that would line up 5 deep all at
once, and the subsequent matches would protect the support level
that had been in jeopardy. So what? We'd also see more such
bids that would line up just below key resistance levels after an
extended runup and the orders would power the index above them.
I'd always thought that the goal of traders seeking a profit is
to buy low and sell high, though perhaps buying high to sell a
little higher works as well. In any event, none of us would
think of using our own money to put on bullish positions just
below key resistance levels after significant runups. This is
the action of participants manipulating the markets using OPM
(other people's money) in the interest of protecting those
markets from what are deemed to be critical breakdowns.

Tracking the Fed's Open Market Operations gives the trader a
window on how much money will be available to the markets that
day relative to past days. Experience will permit you to assess
the impact of different sums- is a $1B drain substantial? Might
the markets tank or just drift? Generally, all that one can know
is how the Fed's daily activity will bias the markets, and so it
is far from a magic indicator. Many traders I know and respect
will not put on bearish positions on a day in which the Fed has
announced a repo for more than a few billion dollars. Follow us
in the Market Monitor each day and start to get a feel for the
impact of the Fed's Open Market Operations. Like most other
indicators, it will eventually help to fill in your overall
market picture in its own particular way.

I have been posting the Fed's daily Open Market Operations in the
Market Monitor and will continue to do so. To follow along
yourself, bookmark the following link:

http://app.ny.frb.org/dmm/mkt.cfm



From OptionInvestor.com

Joe

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