The Known Unknowns


Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don't know we don't know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.[1]

Sec. of Defense Donald Rumsfeld

I was thinking about the SOMA account today; because, you know, that's what you do on a beautiful Friday morning in wine country, and concluded we are going to be hearing a lot more about this in the months ahead. I put in a call to @interestarb to flesh out some ideas and, as always, the conversation was enlightening.

here's the standard op boiler plate from the NY Fed:

and here's the meaty quote : Under this distribution, the Desk anticipates that the assets purchased will have an average duration of between 5 and 6 years. The distribution of purchases could change if market conditions warrant, but such changes would be designed to not significantly alter the average duration of the assets purchased.

SO, the Fed will see 212 B in maturities over the next year representing the apex of re-investment activities. As @groditi has posted about at various times earlier, the Fed has essentially continued a "stealth twist" on the term structure because of their activities. Their hefty (we have called them "just another big clumsy player" for years now) presence is already a concern as to deliverable supply and squeezes on the contract.

The "known unknown" is the possible change to the investment buckets as a way to pre-pave the road to halting re-investment. I have made peace with the reality that my preferred action would be balance sheet first, then rates but the Cognoscenti do not agree. If they continue to act in the present fashion then curve flattening could accelerate after the initial hike or two bumps into a couple hundred billion in buying. If they shorten the duration bucket - another idea I would be in favor of - then the rising funding rate further works against their own portfolio. A third idea, deemed most attractive by @interestarb and myself, ( thus almost certain to NOT be followed !) would be to stop telling participants where and how much they will be buying.

If they shorten the bucket by announcement, then they would spend countless mind numbing speeches proclaiming the adjustment as "technical" and not a "policy adjustment." But If the go silent, and let the Bid to Covers do the talking for them, a refreshing market price discovery for new Treasury issues could emerge. One can still hope. The distrust of market participants (and thus market prices) runs deep at government operations. Our track record gives them decent right to be wary. However, the still significant (212B this year 180B-ish next) FOMC sloshing around in debt obligations is the prima facie case against sound monetary policy by the most powerful economic force on the planet. The time has come to set a better example.

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