US Treasury's $200 Bn Valentines Day Gift to the Markets

We wrote the following in our daily trading letter to clients this morning, and it's worth repeating here:

As we prepare for February, a historically underperforming month for equities, it's worthwhile to consider the liquidity situation. As ZeroHedge recently speculated (subsequently confirmed by Bloomberg), the Treasury will soon begin drawing down its $200 billion Supplementary Liquidity Program. The details will not be available until February 2, but it is estimated that beginning about mid-February, $25 billion per week in additional liquidity will be available as the 56 day cash management bills used to finance the program are not rolled over. Combined with the nearly $28 billion per week of QE Lite plus QE 2, a total of $53 billion per week will be flooding the markets in search of a home. Thus, it's difficult to conceive an intermediate correction developing and any weakness over the next few weeks would likely be an excellent buying opportunity.

We first wrote about Treasury's SFP back in September 2009, the last time it was announced it would be drawn down. We speculated (quite correctly as it turns out) that the additional "stimulus" would lower short term interest rates and would provide more potential market-ramping liquidity (QE 1 Treasury POMO having been nearly completed). At the time (and similar to now) the US was bumping up against its pesky debt ceiling, hence the timing. After Congress raised the debt ceiling, Treasury rebuilt the SFP account to $200 billion from March to April, 2010.

Inasmuch as the Fed's ability to pay interest on excess reserves (which it did not have at the inception of SFP in September 2008) largely makes the SFP irrelevant, we find it curious as to why it was ever refunded. As we wrote in 2009:

Treasury announced special auctions for cash management bills, the proceeds of which were placed on deposit with the Federal Reserve in a special account (as opposed to the proceeds being kept by Treasury to fund the government). This allowed the Federal Reserve to use these funds (which topped out at $558.9 Billion in November 2008) to borrow or buy securities primarily from banks and broker dealers to help “unfreeze the credit markets.” The Fed could have simply borrowed or bought securities with money it printed, but this would have expanded its balance sheet by creating excess reserves in the accounts that banks are required to keep with the Fed [and the funds may or may not have remained as excess reserves].

...

Congress granted the authority to the Fed to pay interest on excess reserves held by banks on deposit with it as of October 1, 2008. This new tool obviated the need for the SFP as the Fed could now simply incentivize banks to not lend against their excess reserves (by paying them interest to keep their reserves at the Fed). Accordingly, in November 2008, Treasury announced it would reduce the SFP, and it has held steadily at $200 Billion for most of 2009.

As yet another illustration of how dramatic liquidity swings by central planners affect risk markets, we find it no coincidence that after the QE 1 spigots were turned off and the $200 billion liquidity drain from the SFP was complete, the May 6 flash crash ensued, wiping out $1 trillion (intraday) in the US stock markets alone. Headlines of debt deflation pervaded the summer and would be used for justification of renewed money printing by the Fed (a/k/a QE 2).

Based on the following White House mid-session budget review published in July, 2010, it was already contemplated that the SFP would be drawn down by September, 2011 (the end of the US' fiscal year), never to be used again.

Which begs the question we echo from ZeroHedge: what liquidity draining method or event lies ahead to be used to justify continued money printing? For the time being, enjoy the ride as the mid-February to mid-April period could see as much as $425 billion ($212.5 billion per month!) in hot money hit the markets. JBTFD indeed.