On Friday I posted a story highlighting the market’s outperformance when the Fed performs its Permanent Open Market Operations (POMO).  POMO is nothing new for the Fed so a one month data set is really nothing more than datamining.  If we look back at the data over the course of the last 5 years we obtain a much more realistic (and potentially disturbing) perspective of the market’s performance on days when the Fed performs its POMOs.

Since October 2005 there have been 205 operations.  On the day the operation was performed the market finished negative 41% of the time, positive 53% of the time and finished flat 6% of the time.  The total return on these days was +27.28%.  This is equivalent to a +48.6% annualized gain.  A look under the hood provides a more useful perspective on the data, however.

Of the days that were positive 63% of the total gains occurred on just 3 days in March 2009.  If we remove these three days the total gains equal +9.98%.  This is equivalent to a +18% annualized gain.  If we remove the best AND worst three days from the set the total return surges to 18.1% or a 33.1% annualized gain.

Perhaps the most interesting perspective in all of this is just looking at the market’s long-term performance when the Fed is conducting these operations.  As you can see below the market has performed dramatically different when the Fed is conducting POMO’s.  The Fed ceased POMO’s in May of 2007 after a fairly steady schedule.  The market declined almost 20% in the following year and a half.  They did not initiate the program again until September of 2008 when the economy was melting down.  Technically, the program began on September 19th 2008 just days before the Lehman crash.  This skews the beginning point of the credit crisis set of operations enormously.  If we take that exact starting point the market fell -2% between then and the last operation on March 24th 2010.  Of course, one could easily argue that the September 2008 operations were largely useless as the market was already in meltdown mode.

Between March 24th and August 17th of 2010 when the program was halted the market declined -6.5%.  Since restarting the program in August the market has risen 8.3%.  The following figure provides a visual of the operations and their (potential) market impact:

For the period of POMO’s from 2005-2007 there were 50 operations and the market advanced a grand total of +0.35% on these days.  Since the market collapse, however, there have been 155 operations and the market has advanced a total of +26.95% on these days.   So, the outsized returns could merely be a function of coinciding with one of the greatest bull markets in history.

What’s so interesting about all of this is the real world impact, however.  These operations don’t alter net private sector financial assets.  Therefore, it’s really just asset shuffling.  The Fed is not printing new money when it conducts these operations.  They’re simply asset swaps.  They don’t add to the private sector’s income, they don’t create jobs, they don’t make the economy better off (aside from a highly debatable and marginal interest rate effect).  There is, however, an obvious argument that there is a high correlation between market response and POMO’s.  So while there is no reason to believe that these operations actually make us all better off there is considerable evidence supporting the idea that these operations correlate with periods of assets being “higher than they otherwise would be” – in other words, assets tend to be disconnected from their fundamentals during these Fed operations.

I’ll be honest with the reader.  When I ran this data I was really hoping that I would find evidence showing that the POMO’s have no impact on market direction.  The conclusion is unsettling for obvious reasons.  And while this might be nothing more than a case of datamining the evidence is convincing that the Federal Reserve is helping to boost equity prices without creating an equally positive change in SUSTAINABLE economic growth.  I’m not a conspiracy theorist, but when I’ve got the Manager of the System Open Market Account for the Federal Open Market Committee telling me that he wants to keep “prices higher than they otherwise would be” combined with this evidence it makes it very hard to believe that the Fed isn’t attempting to outdo Bernie Madoff.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. This isn’t just unsettling. It is frightening. So the Fed is giving the banks fresh cash and they’re really just herding investors into higher risk assets. Then we’re getting a pile-on effect from the higher prices. But all the while, there’s a problem brewing underneath – the real economy stinks!

  2. TPC, how about a thought experiment. Let’s say the FED bought all the outstanding treasuries, what would happen then?

    No new assets have been added, sure, but there’s now much more cash in the system, would some of that cash end up being exchanged for stocks, commodities, other assets?

  3. Someone else might have to confirm this for me, but I am pretty sure that the Fed can only buy up to 35% of an outstanding issue.

  4. I don’t understand much about open market operations, but I’ve heard suggestions that the Feb is somehow manipulating the market and I would like to understand how and if it would be legal. Forget the legal part, I know that the law means nothing Washington, D.C. But, I believe that if the Fed can manipulate the market that it will and I would like to understand how it does it.

  5. TPC,

    first of all, I’d like to thank you for the great work you are doing here.

    Ok, so POMOs drive asset prices higher. But how does it work in practice? The Fed goes out and buys treasuries from Bank A. Bank A has more cash now. Does Bank A immediately goes out to increase its equities exposure?

  6. I do not get how it works besides pure psychological factor (i.e. people misunderstand QE effects and buy risky assets). Given that t-bill can be used as collateral with no haircut to refinance, i do not see the difference at banks level. As the rest of private sector i do not see hedge funds getting more bullish in terms of leveraging themselves…

    i have no clue why risky asstes prices are moving up…except psychological factor…helped by earnings going up (from bottoms…!!!)

    The margin compression arguments and QE effect on commodities makes me more comfortable on shorting US stock markets (with an indutrial bias in selection)…

  7. So did this make you change your long USD / short equity position?

    Seems rather irrefuatable to me.

    This reminds me of 1997/1998…global growth on a tear, sovereign crisis emerging, Fed steps in with liquidity to save LTCM and everything goes completely parabolic for a year and a half.

    The only difference now is that the Fed has become LTCM in EVERY market because they are the market now in everything!

    And somebody needs to tell me this; if $1T in incremental POMO doesn’t work why will they stop there? If the conclusion is that POMO results in no benefit to the real economy yet the market doesn’t care and it goes higher, why will the failure of $1T not result in the market going even higher when the Fed announces another $Xx trillion?

  8. TPC,

    I think it looks like data mining to me. What I do believe is that on any given day or period it can lead to markets going up based on ill founded beliefs. It also may not. Thus, when markets are unsure, at the margin it can lead to a risk trade. When markets are going up anyway it matters little. When reality has set in it doesn’t much matter at all, in fact it can lead to panic as the Fed seems impotent.

    This fits what the data longer term tell me, and it fits neatly in with Hussman’s piece this morning. We see commodity hoarding since people worry about inflation (whether rational or not)and short term asset market jumps.

    The problem for traders on this information is that while it may lead generally to upward moves (when the conditions favor it) the air pockets can quickly wipe out months of gains in days or even hours. The skew is all wrong when it is not based on sustainable growth in the economy, sales and earnings, even if the median is up.

  9. agree – how does this drive up prices other than psychological. Isn’t there already enough reserves to borrow from – is this just a mind game?

  10. Finally you have been converted. Quite a few people told you this and you discounted them out of hand based on the academics and theory.

    Welcome to a banana republic.

  11. It’s painful to be a bear nowadays, never fight the FED, if they want you to go out and gamble, go out and gamble, it’s guaranteed profit.
    The only thing people should watch is inflation, especially in emerging markets, once central banks are forced to tighten, that’s when people should start to worry about the market.
    Go out and buy some stocks folks, it’s not late still. FED can move DOW over 15000 easily, believe it or not.

  12. Never fight the Fed???

    Wasn’t that said throughout 2007 and 2008 all the way to the March 2009 lows?

    Wasn’t that said throughout 2000 and all the way to the 2002 lows?

    I have made good money and, more importantly, not lost money over the last ten years by explicitly ignoring that statement. Will the Dow go over 15k this time? maybe, but if so it will merely show confirmation bias to say it was inevitable because of the Fed. If the Fed had that kind of power the last ten years wouldn’t have happened.

    We are free to make arguments about why it will lead to a sustained bull this time, but it is demonstrably untrue to say that don’t fight the Fed is a always good advice.

  13. Yes, never fight the FED, when the FED is behind the curve, be fearful, when FED is ahead the curve, be greedy. Never fight the FED, never! Or you’ll be a dismal investor, that’s the price of not listening to those FED criminals.

  14. Hmm, so why when I fought the Fed in 2000-2002 and then from 2007 to 2009 was it so successful?

    Look, I am not arguing whether the market will go up, or am I saying ignore the Fed. I am saying the statement that one should never fight the Fed is too broad and/or unnuanced. That is as I said, not an opinion, but a fact. If you mean by the behind the curve statement that it depends on whether the Fed’s policies are adequate to the task at any point, then that is a judgement to fight the Fed when you think they are not. Which proves my point.

    I would still disagree, since there are many times that no matter what the Fed does markets will likely decline (or go up) but of course it is unprovable, since in those instances it is always possible to argue they were behind the curve and did too little or the wrong thing. It doesn’t matter either way though for this discussion, since in both cases one is still fighting the Fed.

  15. Couldn’t agree more. By the way, it’s hard to justify a lng trade here based on risk reward ratio…

  16. FED was behind the curve in 2000-2002 and 2007-2009. I don’t mean to say FED is right, I’m saying FED can create asset bubbles, that’s all. I believe those people in the FED should be thrown into prison, starting from Greenspan.

  17. Level has no meaning, that’s why you shouldn’t focus on levels. Marc Faber has a deep understanding of those things, listen to him, he basically laid out what Ben will do long long time ago, back when stock was in free fall, he said Ben is a money printer and stock market can go any level Ben wants it to be, but economy could be in a disaster.
    Folks, tell the market apart from economy, they are 2 different things.

  18. So are we starting to drift towards Tepper being sickeningly correct about our ‘free market’ economy here?


    Well, he is the billionaire with the 132 percent returns last year.

    Makes investing easier, I suppose. Listen to where the govt wants prices to be, hold nose, follow along. Avg citizens get taken to the cleaners, but those in the know get lifted out, along with the super wealthy. Save the rich – leave your morals at the door.

    At least the scam is being put out in the open now. No more wondering, no more hypothesizing, no more suspicions. Yep, it’s a plutonomy.

  19. We’re already in another asset bubble. This is the greatest dead cat bounce in market history. Be careful at these levels. The Fed is out of bullets and money printing can’t match the credit growth that securitization allowed last decade. Credit is contracting, not growing. This is what Bernanke is signalling by even jawboning QE2 at these price levels. It’s not like we’re about to retest the March ’09 lows.

  20. That is what I wanted to ask you TPC – market is acting as if QE is MONEY PRINTING. Till now I supposed its only psychological and based on misunderstanding. But when you show that the market is up on POMO days, my belief is shaken (of course it could be “smart” traders frontrunning the sheep, which makes it look so mechanical, but…)

  21. While not directly about POMO, in a related vein, someone here recently linked to a series of videos by Ciovacco Capital Mgmt about QE, wherein Mr Ciovacco laid out his thesis:

    * QE is voluntary to participate in – no one is forcing people to sell.
    * QE was eligible for primary dealers and their clients.
    * Who would voluntarily trade an instrument earning say 3% (Treasury) for an instrument earning 0% (USD), unless they planned to do something with that 0% instrument.
    * Thus, QE would likely not lead to ‘cash just sitting in the bank’ at the end of the day.

    Hate to say it, makes sense, IF the QE process is indeed voluntary. Get cash and invest in EMs or commodities.


  22. You are right level has no meaning here, for business involved in INPUTS. pricing inputs are the next bubble obviously, raw matierials. Any retail business will be killed by this, because thier margins will be killed, because thier is no pass through pricing power. The market will roar along until, OIL and energy prices become so high that demand takes another 2008 swan dive and then…..you can probably guess.

  23. “there is considerable evidence supporting the idea that these operations correlate with periods of assets being “higher than they otherwise would be”

    Very interesting observation TPC.

    Y guess Bernie Madoff was just ahead if is time. Ben is a disciple of Melton Freedman and Friedman always argued that the post stock market 1929 crash could have been avoided had the money supply not been reduced.The problem with this to day is that the money is used to maintain the losers not to jump start the real economy. Is this not great the Banksters are in prosperity mode. They don’t even need to lend money any more and it’s all free.

  24. TPC in the quantitative easing operations are there any criterias on what the Fed can purchase or can they swap money against any kind of assets ?

  25. Under current rules, the Fed can only buy up to 35% of any given Treasury issue. That rule can be easily changed, however; there is no structural impediment to doing so.

  26. Agreed on the fact they can create asset bubbles, and as I said, I think it is a semantic issue. If you believe they are behind the curve or using inapproriate tools, then fight them. It will not matter, no matter how many people are saying don’t fight the Fed as we saw in the two major market declines over the last decade.

    The only real disagreement I think we may have is that I believe the “can” in “can create asset bubbles” is a pretty important qualifier. It is also not a given they can create the bubble they want, or is mechanically predictable by market participants in advance, with the possible exception of precious metals. It depends on the environment. Stocks for example, may not cooperate over a number of different time frames, and in a number of different environments.

  27. Yes, commodity price inflation will kill it, I agree, that’s where the focus should be (and the emerging market inflation).

  28. When liquidity is ample, earnings are good, stock market is all about psychology. The dynamic move is about psychology, not about the absurd cash on the sideline accounting identity argument, that’s a static view and wrong.
    FED handed you a put, you don’t go out and buy?

  29. I think Martin Armsstrong has a point when he says stock markets are always aout knowing the flow of capital. This is going to be the repeat of capital flowing from public assets (govt bonds, because capital is intelligent) to private assets (stocks equities, corp bonds,commodities because capital wants to save the “capital”) till the ultimate darkness. Its going to be collosal, the size of correction is going to be of quintennial in nature.

  30. It’s been no secret that the government has been sustaining the financial sector by whatever means perceived necessary, supporting housing prices by flattening the yield curve, and depreciating the dollar relative to other major currencies, all of which are positive for equities, given the rotten real economy with vaunted corporate profits the result of lower expenses rather than rising revenue from increasing sales. Without these actions, stocks would still be in the tank and the economy would be a smoldering ruin unless we had a huge stimulus package aimed quickly at the bottom of about 2 trillion in spending and a payroll tax holiday.

    What happened to spark the bear rally in ’09? The government twisted arms at FASB to get them to permit mark to model instead of mark to market, covering up the big banks insolvency. That coupled with rigged stress tests has propped them up so far. The market inversely tracked dollar depreciation. But now foreclosuregate threatens yet another crisis that Congress rushed to fix but the president, to his credit, pocket vetoed — until after the the election. This is one big stinking mess on top of another, but the government is in there pitching.

    People like Tepper and Gross know this (there is good reason to suspect that they get inside info since Gross said as much) and they have done very well since the beginning of the crisis following Uncle Sam, who essentially runs the game. You can call it manipulation if you like, but the government calls it emergency policy.

    Will it work? Well, it has prevented the deep and extended financial crash that would otherwise likely have occurred, but it is just papering over rot and that is unsustainable. Unless Congress follows through with an expansionary fiscal policy that sustains the real economy until consumers rebuild their balance sheets, it seems doubtful that the Fed can hold things up by itself. Odds are for another leg down in Great Depression II that began with the fall of Bear in March 2008. We are at about the first quarter of 1932 in terms of GD I, if this scenario is correct, and the odds are increasing that it is, since austerity is the latest global fad.

  31. Isn’t the first rule of statistics correlation does not imply causation? There are so many confounding variables in this data set that I can’t believe you’re even asserting this case, TPC. I’m sorry, but the run up from March 2009 to April 2010 was really just been about things not being end-of-the-world bad. And until any current slack in the economy starts really hitting corporate income statements, I wouldn’t expect the bear thesis to speed up further. That’s not to say there’s a ton of upside here forever: There isn’t. But Flash Crash 2.0? Well, good luck betting on that.

    This whole time period has just reinforced my thought that 99% of market commentators don’t know what the hell goes on and resort to any excuse to explain away short-term market movements. Heaven forbid a bear thesis miss a data point or make a faulty assumption! That never happens!

  32. It’s so nice to see someone (aside from myself) make this argument. I agree. The “don’t fight the Fed” commandment of investing really gets on my nerves. Like most investing axioms, it is incorrect. Right up there with “the market knows the future and discounts it”. Right.

    I have made money fading the Fed and going w/ the Fed. And lost money doing both as well. There IS no formula. The key is to try and know WHEN to fight the Fed and when not to. Good luck with that. heheh.

  33. Ciovacco says new money has been added to the pvt sector. That is inaccurate. But his beliefs are mainstream misconceptions so asset prices move accordingly….

  34. There is a psychological impact in all Fed speak. But ultimately, the Fed can’t create jobs. So, if there is a psychological impact on prices, the question is how long does it last before the market realizes Ben isn’t creating any economic benefit?

  35. I fully admit this could just be a fancy case of datamining. The conclusions are absolutely not rock solid by any means, but the data raises some serious questions.

    And trust me, I went into this research hoping that I would be able to prove that these Fed ops do nothing. I envisioned writing a piece proving all this POMO nonsense wrong. But my conclusions were the exact opposite.

    Plus, I fully recognize that the economy is better off than it was in 2008 and I fully understand that govt can have a positive impact on markets. After all, I was bullish in March 2009 entirely because of govt intervention and a belief that the market was overreacting.

  36. Johnny,

    While I agree on your overall statement, I do not see why it has anything to do specifically with bearish arguments. In fact, given the overwhelming, all the time bullish arguments of most commentors on the markets, it is a bit odd to make such a comment. TPC himself acknowledges it is not proof of anything, but is something to consider.

  37. What I don’t understand is why would entities participate in QE when there’s a perfectly good market out there already? It’s not like Treasuries are not in demand at the moment (unlike, once upon a time, MBS, when the Fed was heavily buying those), so what’s the point of QE exactly? To buy something that no one seems to be able to get enough of? It really does seem like the biggest non-event in history. Why sell your T-bonds to the Fed for cash to invest in copper when you can sell your T-bonds to the Chinese for cash to invest in copper? What is the Fed offering above and beyond the private market? Better prices? A commemorative pin? Favorable treatment in the future. Happy ending?

    Having said that, I do like the case Ciovacco makes that it doesn’t make sense to sell a bond for cash if the seller isn’t planning on doing something with that cash afterwards. I understand that ultimately no “new” money is added to the system from this. But if you want to buy copper, you gotta’ sell something in the portfolio to get there. Why, however, sell to the Fed as opposed to others I don’t understand at all.

  38. Unless, I suppose, the whole point is to create more of a market than actually exists with an artificial demand, flushing the financial system with a larger % of cash than it would otherwise have, which – financial people being who they are – would be used to purchase other assets.

    Perhaps it is just that simple. Taking the “safer” choices away.

    As Hickey says, “You can call it manipulation if you like, but the government calls it emergency policy.”

  39. A lot of newer readers think I am a permabear….I’ve explained my position on the market 100 times. If people don’t keep up then they don’t keep up. No big deal.

    I’ve been bullish at many of the most opportune moments over the last 18 months. The fact that I believe we are in a secular bear is merely due to my belief that the macro trends and balance sheet recession are negative headwinds. Within that, you cannot just be blindly bearish OR bullish. You must trade this market to make money. Just my opinion.

  40. The mistake he is making is that they are selling it necessarily to do something. How about the fed will offer what it takes for them to sell? I know if I have a bond, if buyers come out and start offering to buy, at some point I am willing to sell. I do not have to have something planned for the money right away, it is just the price I am willing to accept to part with the asset. Primary dealers are no different.

    In addition, to purchase copper, a primary dealer does not need to sell the bond. They just need it as collateral. For primary dealers t-bills and bonds are pretty much the same as cash reserves. The only questions are “do I want to buy copper?” and “is that a price at which I am willing to sell the bond.” Neither is connected to the other.

  41. No disagreement there TPC. This is not, and hasn’t for some time, been anything but a traders market, though the timeframes have varied widely.

    As for perma bear, I have actually met very few, and you are definitely not one. Grantham gets the same thing, even when he calls the March bottom or when he says that despite his long term concerns the market will likely go up. he ius a bear because he disagrees with why it will go up. The complaining about bears has become a tired sport, especially considering their rarity.

  42. People who are regular readers are familiar with my track record. I was bearish in 2008, early 2009, turned bull March 2009, cautious over summer, was bullish heading into 2010, turned bearish April 2010, etc.

    These calls are all verified in real-time. I am a macro bear, but certainly not a permabear. Anyone who says so is obviously a new reader.

  43. I was bearish in 2007 and 08, cautiously bullish in March of ’09, cautious at the beginning of the year and bearish by April.

    Not far apart, and that would also explain why I have enjoyed reading you. Only just started commenting the last month or so, but I have long enjoyed your work.

    People have their own view, get irritated when people do not agree and resort to epithets. Looking critically at a body of work is way too much for them to attempt for the most part.

  44. The thing is that when you peg me as a permabear it implies that I’ve been wrong for several years, which is just flat out untrue. I’ve been wrong. I sold too early in 2009, I was a month early in April 2010 to short, I was bullish August and didn’t act, etc. But for the most part I’ve gotten the disinflationary slow growth macro picture exactly right while also trading the market with fairly precise timing….

  45. Good points.

    Okay, PDs or their clients may not have something in mind to buy today, but they aren’t paid to sit on cash, either. I’m aware of few financial managers who make money sitting on cash. Financial money chases yield. And 0% is no yield. Perhaps a hedge fund or two is patient in this way, waiting for the right moment, but most are not. Also, if they weren’t going to do something with that cash at some point, then the entire QE program would have no constructive effect whatsoever, even in a conceptual form (being ultimately deflationary). Since it appears to be having some sort of effect, then obviously the majority of people are not just “sitting on the cash” after the sale. Oh yes, they could … but it does not appear that most are. I think the likelihood of cash being used still outweighs the potential of after sale cash just sitting around.

    As for the second point, borrowing still has costs. If you’re going to use the T-bond as collateral, you’re going to give up some of that return compared to if you outright sold it. Perhaps I’m wrong here, but for smaller entities (clients as opposed to the PDs) I think the concept of using other instruments (like say a huge block of safe home mortgages) as collateral is waning.

    If, however, you are correct, then the QE process is one of paying too much for an item simply to give the seller more money than they would otherwise be able to get from the natural market. Which would appear inflationary to me. If the Fed is willing to buy a bond that would “normally” sell at 102 for 105, say, then that difference of 3 is an unnatural input into the system. Not as egregious as paying 100 cents on the dollar for CDOs worth 60 cent on the dollar, but still adding more cash into the system than would otherwise naturally exist. If the Fed were buying at unmolested “market rates”, then I would see no additional inputs into the system, but if they are buying at, as you seem to suggest, elevated market rates, then that does seem to create additional inputs into the system than would otherwise naturally occur.








  47. PS,

    the arguments are good, but we have heard them / know them already. You always repeat the same, so it looks like a priest trying to convert someone. Better provide some new analysis / factoids as to why you are likely correct. The El-Erian observation is a good one. On the other hand we have had ebullient (inflationary / Fed induced) markets in Sep-Oct 2007, May-2008 (in commodities), March-April-2010, and there were always steep sell-offs afterwards.

    Of course the inflationary trade may have become the dominant long-term structural trade, but just 2 months ago the deflationary view was quite well-accepted.

  48. Well the treasuries are auctioned of. The Fed enters and would buy them at any price. This drives down interest on the Treasuries and as the auctions are oversubscribed more of those willing to buy new Treasuries can’t. There are institutional investors that receive monthly cash and feel the need to be invested 100% at any time. If they can’t buy AAA Grade Bonds they have to switch to something else that’s still at least investment grade, meaning some corporate Bonds or certain Equities. This of course drives overall asset prices because it should move everyone into riskier asset classes if the underlying valuation changes. That’s at least what Bernanke assumes, and others assume so as well (“don’t fight the Fed”) so they try to buy those riskier assets to sell them later at a higher price to those that moved down the food chain because they can’t buy Treasuries with a reasonable yield anymore. Ultimately what they think is that those chasing higher yields start lending irresponsibly again, thereby propping up house prices, which encourages others to take money out of their home to spend it on stuff, thereby hopefully helping the real economy.

    Bernanke would probably be wiser to just drop the money out of helicopters, that would at least put money directly in the hands of Main Street People (you know, like Joe the Plumber who wants to keep his Bush Era tax cuts on his over 300k $ income).