The Precise Take – Equities consolidating yesterday’s gains ahead of opex Friday

Big Picture Analysis:  The Federal Reserve Bank of New York conducted its first Treasury permanent open market operation (POMO) yesterday–the first such since October, 2009.  Long time readers will recall that there was a strong correlation between POMO days and paint the tape closes in the second and third quarters of 2009.  Yesterday was nearly the reverse, as equities rallied throughout the morning auction and shortly thereafter, but sagged on the close.  A sample size of 1 a trend does not make, but it to seemed to be a blatant risk-supportive signal.  Also noteworthy was the large decline in 10 Year T-Note futures, suggesting that their recent parabolic rise could have been mere front-running of the Fed–financial institutions bidding up coupon Treasurys in anticipation of selling them at a profit back to the Fed.  The amount of Fed purchases ($18 billion for the first month) is a bit less than 2009, so it remains to be seen if the 2009 effect can be duplicated.  It’s also possible the money will be directed…

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After an initial failed test of the 8:30 am spike high to 1048.75, longs have supported the ES in the expected area of 1037.25 to 1039.50 per our morning report.  If the ES accepts value in the upper half of the combined session range (1043.50 and higher), there could be a successful afternoon push to new highs, as we have seen in previous days.  Otherwise, the conditions for this morning’s high being the September high are partially in place.  We would like to have seen a directional push down by now, but a close under 1030 still signifies the top is in for us.  For this reason, we will not be buyers on any further weakness (including test of 1038.25 low), and will instead begin intraday shorting on a break of 1037.00, should it occur.

Treasury Analysis:  Today is the first of three major auctions this week for Treasury securities—today is the 3 Year, tomorrow the 10 Year and Thursday the 30 Year.  The 30 Year T-Bond future backed off its major resistance are Friday on the equities advance, nearly reaching the 50% retracement support at 118 7/32 from the August interim low.  As equities are now testing highs, key will be to watch the 30 Year’s reaction this week to the various auctions with 117 4/32 to 118 7/32 containing the Fibonacci box from August lows and VWAP anchored from the June 11 09 low of the year.  If we do get reversals this week in equities (down) and Treasuries (up), it will most likely be from this support area by early tomorrow (though possibly after the 10 Year auction at 1:00 pm tomorrow).  We expect Treasury auctions to be the biggest news items of the week and they should be watched closely.

Gold:  Gold futures broke through 1000 overnight (high of 1009.40 basis Dec 09), but we would like to see confirmation with gold priced in Australian and Canadian Dollars break through swing high resistance from late June to mid-July 09.  Until that happens, we consider the rally based on Dollar weakness, and not yet sufficiently broad based to signal a strong move up.

POMO:  Today is the only day on which the Federal Reserve Bank of New York will conduct permanent open market operations for Treasury securities this week (though it will likely announce another Agency POMO), and the Treasury program is expected to end with next week’s two POMO days (Sep 16 & 17).  The program was prolonged to end in October 09, but will likely reach the $300 B cap in next week’s auctions.  In the unlikely event that the program dollar cap is increased, expect violent moves in both Treasuries and equities.  Both have benefited from the program—Treasuries because POMO supports demand and equities because the proceeds appear to have been channeled into the stock market.  However, the markets may call Bernanke’s bluff and any prediction on an eventual reactionary move is extremely speculative.  Though the day trading POMO pattern of paint-the-tape closes had subsided, it was resurrected with last Thursday’s strong close (it was a POMO day for Agency securities).  The Treasury POMO program could end with a bang rather than a whimper into next week, with every last leveraged dollar from the proceeds squeezed into equities, so just a word of caution to the shorts.

Trading Today:  While we are not surprised to see the ES up again at the highest market profile value area (primarily because of gold strength and the correlation we noted last week), the rally was not on what we would consider a clean NFP reversal.  Rather the move began a bit high (10 points off the lows) to consider the NFP pattern to have held.   Back to market profile, if the ES continues to accept value above 1019-1020, there is a good chance we will see new highs.  If current highs are to be respected, the ES should reject this area by early tomorrow.  We are willing to go long in an early retracement into the daily gap/pivot area of 1019.00 to 1021.75, but become intraday bearish below.  Despite this, we will likely avoid…

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Gold:  Thanks for all the responses to our posts yesterday regarding the breakout in gold.  We will have additional thoughts to be posted intraday today.  For now, gold has indeed advanced higher again overnight, but we don’t expect a confirmation of the breakout until at least tomorrow, if not early next week.

Time Profile:  Today is an Agency POMO day; however, as we wrote Tuesday morning, the POMO edges have dwindled to nothing recently.  Additionally, we believe the Agency POMO effect of the last two months was helped in part because most of these days were Friday’s, which have had a bullish bias since March.  Accordingly, we’re not posting a Time Profile for today.

Employment Situation (NFP):  As we have noted before, the March rally was kicked off on an NFP day, and every subsequent report has been at an important support or resistance level.  As we are now in the bottom range of the week’s range, the probability (if the pattern holds) is for tomorrow’s report to result in a spike low that confirms ~991 as support in the ES, and leads to a rally into next week.  This would also confirm the positive correlation between gold and equity prices.  As always, though, we must be prepared for when patterns break, so it could be that tomorrow’s report will result in an extension of the down move.  We will have more information in tomorrow’s report (published just after the report) for what we expect the resulting move to be.

Market Profile:  As evidenced by the market profile chart below, the ES is still in the value area centered around the 995.25 point of control.  Should it break out of the value area (higher than 1006.00), it will likely test at least the minor point of control at 1016.50.  A quick rejection off that area is a very strong sell signal, but not likely to be reached today.  Above 1016.50, and the next point of control is 1024.75.  If the ES breaks above and starts accepting value there, new highs are likely.  To the downside, a break below 991.75 suggests a test of the 973.25 point of control, again not likely today.

Trading Today:  We are expecting another low range day and would fade the 1004.00 to 1006.00 area short on weakness (quick rejection of the area).  If the ES hangs around in the upper range and starts building volume there, then we would prepare for a move up to at least the monthly pivot at in confluence with daily R3 at 1011.50 to 1012.50, where again we would…

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What type of GSE direct obligations will the Federal Reserve purchase under the program?

…Prior to August 31, 2009, purchases were focused on off-the-run securities in that category. Going forward, purchases will include on-the-run securities in that category. This change represents a technical adjustment designed to mitigate market dislocations and to promote overall market functioning.

So, the Fed will now buy newly minted Fannie and Freddie debt (are they running out of older debt?).  Overall, not a big leap (it’s only a $200 B program), but another small step up the ponzi pyramid.  Next, expect loosening of restrictions in the much larger TALF and MBS programs. 

Gaming the Market outlines a typical day at the FRNY trading desk.

Step One (08:30am):

• gather information, macroeconomic news
• desk telephones primary government security dealers
• large banks inform the desk about their reserve needs
• NY Fed gather data to provide forecasts of reserves

Step Two (10:30am):

• call to the Treasury concerning its forecast of its balance for the day

Step Three:

• formulate the actions for the day
• forecasts from Treasury, NY Fed, and Fed BoG combined
• interventions are formulated
• trading plan is formulated

Step Four (11:15am):

• conference call links…
• Manager (and staff)
• Director of the Division of Monetary Affairs at Fed BoG
• a Federal Reserve Bank president who sits on FOMC
• proposed actions for the day are detailed

Step Five (11:40am)

• desk traders contact primary dealers and execute day’s program

Update 2:58 pm:  We didn’t expect to proven correct so quickly!  The Fed just announced it is extending TALF (Term Asset-Backed Securities Loan Facility) from Dec 31 2009 to Jun 30 2010 for newly issued CMBS and Mar 31 2010 for newly issued and legacy ABS.  And, no longer will borrowers from the TALF be restricted to using primary dealers (who have the onerous requirement of buying up Treasuries at sloppy auctions).  Now, there are TALF Agents, with four non-primary dealers named today:

• CastleOak Securities, LP
• Loop Capital Markets, LLC
• Wells Fargo Securities, LLC
• Williams Capital Group, LP

No major changes to the Terms & Conditions of TALF, though we expect eligible collateral standards will eventually be loosened again.

Update 3:15 pm:  As to the above list of TALF Agents, all but Wells Fargo appear to be minority-owned and part of the Fed’s Partnership for Progress program.  So why was Wells Fargo thrown in?  Perhaps because it is the largest bank that is not already a primary dealer.

Time Profile:  Today, the Federal Reserve Bank of New York conducts permanent open market operations (POMO) for Treasury securities.  The POMO tape-painting effect has all but disappeared, as evidenced by the charts on page 2. While the noticeable edge was a bullish first hour in July, August reversed the trend with a bearish first hour, mainly due to opening gaps.  Today, we expect an opening gap to the downside, continuing the August trend; however, we can offer nothing more as to the balance of the day from the Time Profile alone.

Trading Today:  Overnight, the ES filled within a tick the market profile volume gap that extended to 1010.50 after selling off at the September 09 contract’s highest point of control at 1025.50.  We would be sellers on an early retracement to the daily gap/pivot area of 1018.50 to 1021.75.  We would also sell a spike high and subsequent reversal on the 10:00 am reports as long as…

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Treasury Analysis:  We wrote yesterday that the inability of equities to make gains off bullish to neutral news this week was bearish.  However, their ability to rally in the face of the above average 7 Year auction yesterday is bullish.  It looks like the strong resistance area we noted yesterday in the 30 Year T-Bond futures is proving too difficult to traverse, and without money flowing into Treasuries for the time being, equities are able to gain. 

Time Profile:  Today is a day on which the Federal Reserve Bank of NY will be conducting Agency permanent open market operations (POMO).  The ES has been deviating more and more recently from the POMO Time Profiles, however, we believe it is prudent to be always at least be aware of the statistical tendencies.  For Agency POMO days (nearly all of which have been conducted on a Friday since June 09), there is a slight bullish bias for the day, especially from the 2:30 pm to 3:30 pm hour, with the final 45 minutes having a slight bullish bias, but tending to be more of a mixed bag as indicated by the range of Net Points (thin grey line).  The bullish bias for the day was much more pronounced from Mar 09 to May 09, but still exists and should be considered. 

Trading Today:  As we write, Personal Income & Outlays at 8:30 am has not moved the markets materially.  Accordingly, we have a bullish bias into Consumer Sentiment at 9:55 am, upon which any significant deviation from expectations will likely lead the direction of the markets for the day.  If it’s within expectations, we’ll likely have a…

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The day has turned from bearish to neutral now, so we don’t have a directional bias into the afternoon, except for the statistical tendency to have a bearish closing hour because of yesterday’s POMO.  Accordingly, we consider any positions entered in the middle of the day’s range to be aggressive, preferring to fade the range, with stops close to the extremes.

Leaders:  Because 30 Year T-bond futures held support last week and advanced as equities held their ground, it is in very good shape to weather next week’s (likely) record breaking auctions.  We wanted to see a close above 119’08.5 in the 30 Year this weak and, after poking above it Friday, we could get it today.  The announcement of next week’s auction amounts will be this Thursday at 11:00 am.  At 9:00 am today, we will get a look at the monthly Treasury Int’l Capital report to gauge continuing foreign interest in the US’ long term Treasuries.  The data will be six weeks old, but it is important nonetheless.  On the overnight weakness, gold has broken last week’s lows and the EuroYen forex cross is down sharply as well.

Time Profile:  Similar to our comments from Friday, today’s time profile suggests that we could have another strong close, despite likely being net down for the day.  Strong closes on POMO days have historically been reversed the following day.  The July rally erased this edge temporarily with several strong follow up days.  However, with renewed weakness in equities, it may be time to revisit these plays and short weak issues on a strong POMO close.  If the close is weak instead of strong, we would want to see other reasons to short.

Trading Today–Putting it all together:  We do not get intraday bullish unless and until the ES can climb over the 995.50 market profile point of control from Friday.  Below that and we’re primarily looking for shorting opportunities, though we would fade long at the next lower long term point of control at 973.25, if we saw buying come in.  Overnight, the combined day and night session daily S2 has provided support and shorts will want to break this area early to continue the directional move.  Assuming no major disturbances in the 9:00 am TIC report noted above, the key news item for the day will be

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Longs in the ES need to push back above 1006.50 to have a chance at a strong close and will likely defend the 994.00 market profile point of control heavily and aggressive longs could fade long this area on a short time frame double bottom.  New shorts will be difficult to enter as this is shaping up to be a strong directional down day with few retracements.  If the ES rallies off 994, then we would hold out for the 1000 level or 1004, not hanging around short above 1006.50. 

Should the ES close below 994 today, we expect the rally is at least temporarily over and for declines to continue into next week.  Also recall that today is a POMO Agency day, and there is a good possibility of a rally from 3:30 pm to 4:15 pm, so day trader/swing shorts may want to cover prior to this time.

Treasury Analysis:  Yesterday’s 30 Year auction had solid support, allowing the 30 Year T-Bond future to reverse its prior day loss.  The next test will be Monday’s Treasury Int’l Capital report at 9:00 am, which will reveal the holdings of the big name purchasers of US long term debt, then next Thursday’s announcement for the following week’s auctions of Treasuries, which is expected to continue its uptrend and be for a record amount.  The 30 Year looks to be in good shape short term, but we would like to see it take out the 119’08.5 swing high sometime next week. 

The Federal Reserve Bank of New York (FRNY) had already scheduled POMO for the coming Monday and Wednesday prior to the FOMC announcement.  Based on the tentative maturity range, it looks like they will not be buying this week’s supply (3, 10 or 30 Year).  As has occurred each Friday for the last five weeks, the FRNY will be conducting a POMO for Agency securities today.

Time Profile:  The Time Profile for all Agency POMO days that have occurred on Friday since the beginning of the March rally (n=14) has a slightly bullish edge into mid-day and a very strong paint the tape close.  However, for July going forward, the edge becomes bearish in the afternoon, with a tendency for a weak close.  This could be because each of these recent POMO Agency Friday’s has been preceded by a regular POMO day, which tends to have a bearish close on the following day.  Accordingly, because yesterday was not a POMO day, we believe the possibility of a strong close is greater today than the previous five Fridays, even if the day is net down up to that point. 

Trading Today–Putting it all together:  We weigh the markets’ reaction to news as much, if not more so, than the news itself, and have expected CPI to be…

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Another scenario for consideration is that (1) QE is not renewed in the FOMC Announcement tomorrow, which would otherwise be bearish for Treasuries and (2) the 10 Year and 30 Year auctions this week have such strong foreign interest that they avoid a downturn.  With another ~$70-80 B in POMO money set to come into the markets over the next month and another (likely) record breaking set of auctions set for the end of the month, this is risky for Bernanke.  However, nonrenewal of QE and strong auctions this week would send a very confident signal to the Treasury market this week.  Raising the interest rate on excess reserves or hinting at tightening could also help to stem the dangerous advance in equities; however, as we have said before, Bernanke does not want to be seen as putting in the top in equities. 

We don’t envy his position and don’t front run big news.  However, for those with positions on, our continuing thesis is that, one way or another, equities will correct this week and Treasuries will advance (with yields turning down).  For the grand scheme to be a success, we’d like to see the 30 Year close over 119’08.5 resistance this week.  If there is a close under 114’30, the march up in yields will become a threat again.

The POMO auction was strage today, as Zero Hedge reports.  Any bullish trading edge left over from the prior POMO day was expected to disappear by mid-day anyway (and apparently disappeared long before the open today), so we will now guide ourselves by other factors. 

The only leader that did not confirm the equities downturn today was gold, which equity bears will want to see breach support tomorrow.

Overnight, 990.00 support will be the level to watch, with 983.75 to 999.50 unlikely to be breached either way.

Yesterday:  We wrote

[W]e would like to see a break of 998.50 early before entering shorts and indeed may fade long this area if buying comes into the ES.  We would also expect longs to come in at the 994.00 to 996.00 area.  If it turns out to be a range day (likely), the downside will be trickier to trade than the upside.  Above, and we don’t get outright bullish until above Globex highs at 1007.75 [corrected from 1007.50].  1010.50 to 1015.25 has very little resistance. 

The ES could not break the overnight high in early trading yesterday and ended up testing Friday’s day-session’s low of 999.50, with a final probe down to test our critical support of 998.50 (low of 998.25).  This area was quickly rejected and breakout shorts were forced to cover into the close.  When a high confluence support area is breached by a point or less and quickly reversed, it is often a clue that the reversal will continue from forced covering as it did yesterday.

Today’s News:  The 3 Year Auction at 1:00 pm will be the one to watch as an indication of long term Treasury interest ahead of the 10 Year (tomorrow) and the 30 Year (Thursday).  As we wrote yesterday,

[A]s we have seen recently, the smaller auctions can go poorly as long as the last longer dated auction of the week goes well.  Therefore, it has more bullish potential for Treasuries (bearish for equities) than vice versa because weakness will be downplayed.  This week is the last holdout for Treasury longs and we expect much volatility into Wednesday and Thursday, though today will likely be quiet.

POMO:  Yesterday and today are days on which the Federal Reserve Bank of New York conducts permanent open market operations (POMO), for which we have developed trading edges with the help of others*.  Yesterday’s price action fit Graph 3 from our Sunday post quite closely after the first hour (see page 2 for the comparison with actual price action).  The tape-painting into the close effect had been diminishing recently with gains concentrated in the preceding afternoon hour, but resurfaced yesterday.  Generally, we were bullish into the afternoon and early trading today, which is what has occurred.  Today’s time profile has a bullish edge into the morning, but turns bearish around mid-day. 

Big Picture:  We don’t have much to add from our Big Picture segment from yesterday’s report regarding the FOMC Announcement and Auctions.  Regarding the leading markets we follow, we wrote:

[The leaders] are not yet pricing in further equity gains this morning.  The EuroYen cross, an important barometer of risk taking is testing its June highs.  A break through resistance would signal expected further gains.  Gold is off its Thursday highs and curiously did not advance on Friday’s gains in equities.  Also, the 30 Year T-Bond is holding support at its July low, but just barely.

Gold and the EuroYen cross finished the day materially lower, with gold bouncing off a 61.8% Fibonacci retracement from its July 29 low, which has held overnight.  Overnight, the EuroYen has lost further ground.  The big winner yesterday, however, was the 30 Year T-Bond future, which formed a bullish engulfing candlestick pattern on the daily chart after testing critical support.  This puts Treasuries in a good position into tomorrow as even a weak 3 Year Auction today will likely not cause the 30 Year to break support.  All in all, the leaders are still not pointing toward new highs in the S&P 500.  Gold will be the likely leader if this pattern reverses, so we’ll watch for a strong move up as an early indication that equities could see another strong run up.

Trading Today:    Putting it all together, we are not expecting a…

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Friday:  After a strong bullish premarket push up to the 1007 area resistance, the ES retreated a bit , but was able to break through a few minutes after the first hour.  As we updated intraday:

The R1’s were exceeded premarket, but the double top of the last two day’s in the 1,007 to 1,008 area have proved to be the stumbling block.  If the ES cannot exceed by 10:30 am, we would move stops up on any longs and resist taking new longs unless and until the resistance is cleared.  We now become bearish below 1,000 and would look for shorts below that area.

The close was not as strong as the bulls would have liked, but overhead resistance was cleared and we have a clear break of the 1000 level on the long term charts.

Looking ahead this week:  With the 10 Year auction that needs to show strong foreign interest and the FOMC Announcement on Wednesday, and 30 Year auction on Thursday, the markets will be looking to tomorrow’s 3 year auction at 1:00 pm for clues.  However, as we have seen recently, the smaller auctions can go poorly as long as the last longer dated auction of the week goes well.  Therefore, it has more bullish potential for Treasuries (bearish for equities) than vice versa because weakness will be downplayed.  This week is the last holdout for Treasury longs and we expect much volatility into Wednesday and Thursday, though today will likely be quiet.

POMO:  Today and tomorrow are days on which the Federal Reserve Bank of New York conducts permanent open market operations (POMO), for which we have developed trading edges with the help of others.  See our overnight post that updates the time profiles for today and tomorrow.  In short, the paint the tape tendency is diminishing as we’re seeing many of the day’s gains finished by 3:30 pm on POMO days in this July rally.  Also, the first hour today could prove tricky as we have some conflicting information.  We would look for a break of 1007.75 to the upside or 999.50 to the downside in the first 15 minutes to see if there will be a directional edge for the morning.  If we go down initially, longs may want to hold out, looking for a low into the hour that closes at 1:30 pm.  For the July rally only (n=5), there is a very strong tendency on the second day of a back to back POMO set to see a strong open and continued gains until about mid-day, after which we have been getting very weak closes.

Big Picture:  In the ongoing saga of Treasuries vs. equities, we feel this week is the last holdout for the Treasury longs and that it’s do or die for the Fed.  As we’ve been writing, the potential disaster that awaits with long term yields breaking to new highs is much greater than a stock market correction.  However, institutional sentiment seems to be that the Fed will simply let QE expire when it runs out of money or time (six months from announcement on March 18 09) in September.  The FOMC could wait until the next meeting in about six weeks to renew, but yields will likely have gotten away from Bernanke by then, and a hinting of a rate increase (which could correct yields) is too politically dangerous for Bernanke, who would not want to be seen as having single handedly put in the last stock market top.  Accordingly, while we still find it likely that QE will be renewed on Wednesday, we must prepare for a Fed that stands idly by as the Treasury market disintegrates and for the monster rally in equities that could accompany.  Until Wednesday, we will tread carefully, but we expect to have an answer by Thursday on where we are headed over the next few months.

The leaders are not yet pricing in further equity gains this morning.  The EuroYen cross, an important barometer of risk taking is testing its June highs.  A break through resistance would signal expected further gains.  Gold is off its Thursday highs and curiously did not advance on Friday’s gains in equities.  Also, the 30 Year T-Bond is holding support at its July low, but just barely.

The Big Rally:  We hinted at a massive equities rally that could continue from this week’s news.  There was very little transacted volume in the markets from the area of 1000 to 1200 on the S&P 500, which takes one form of resistance off the table.  Also, as our friend Billy O’Nair has researched, the S&P is now 15% above its 200 day moving average, which has historically led to further gains in the following three months.  In this environment, overbought and oversold are largely irrelevant and mean reversion strategies are indeed getting hammered.  A note of caution, however.  The only time the S&P 500 has been 15% over its 200 day MA in the late summer or fall was the second week of August, 1987.  Go to your charts if you don’t recall what happened a few months later.  The time of year is critical, because, as we have studied, M2 volatility (at historic highs now) can exacerbate corrections in equities that become self-feeding.  If we get a reversal this week, we are very skeptical about the ability of equities to break to meaningful new highs in the subsequent weeks and will be on alert for crash signals into October.  We’ll also throw out that the NFP Friday was a spike high and NFP have been reversal days this year, while FOMC days tend to be trend continuation days.  Again, we need to wait until Thursday for confirmation of everything.

Trading Today:    As we write, the ES is entering our intraday bearish area at 1001.50.  However, we would like to see a break of 998.50 early before entering shorts and indeed may fade long this area if buying comes into the ES.  We would also expect longs to come in at the 994.00 to 996.00 area.  If it turns out to be a range day (likely), the downside will be trickier …

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Not much time here, but we will have more in tomorrow’s morning report.  For those that are planning for tomorrow’s action, please consider the below.  Also, ignore any dates in the “x” axis of the graphs.

Graph1:   The tape-the-paint tendency has been fading since the July 09 min-rally, in favor of the 2:30 to 3:30 pm hour.  Also, note the strong opening hours.  Even though the auctions have not yet occurred (they start at 10:30 am), could this be frontrunning as people are catching on?  Perhaps, because this opening bullish edge completely disappears for non-POMO days in the same time period (not shown).  Measuring the edge from the July rally forward appears to be important, but it necessarily reduces the sample size.

 Graph 2:  This covers each of the days from July to present for which there has been an Agency POMO on the preceding day (all were Mondays–important–and have enjoyed great strength.  Note too, that Monday’s are usually quiet news days (as is tomorrow).  Unfortunately, sample size is necessarily small.

Graph 3:  This is the one negative factor for tomorrow morning because, going back to the beginning of POMO (Mar 25 09), a POMO day following a POMO (Agency) day has had a tough opening hour.  We’ll filter our bias based on the price relative to Friday’s close 1-2 hrs pre-open.

Graph 4: This is this Tuesday’s Time Profile because it is a POMO day following another POMO day.  Note the tendency for a strong first hour, but negative performance after 1:30 pm.

Always remember the following:  The “edge” is an evolving target.  You would need to take every trade on a given edge to produce the graphed results.  Because the edges are often discovered with 20/20 hindsight, this is not possible.  All we are alerting to here is that traders might want to be more receptive to certain trends and possible reversals in certain periods of time.

1010.50 to 999.50 is our projected overnight range, assuming no major developments, and the opening price of tomorrow’s day session relative to these numbers and also Fri’s settlement of 1006.50 will be important to our projection for the day.

We will have much more tomorrow, including an analysis of whether or not the amount of buyback on POMO’s  by the FRNY from primary dealers of the dealers’ inventory acquired at previous Treasury auctions has any trading edge (hint: it appears to).  Thanks to Zero Hedge for his painstaking work on this over the weekend.  Thanks to the members of the Value in Time Group for their invaluable contributions.

Yesterday:  Bulls should have been able to extend the overnight gains and, instead, sold off sharply on the premarket push to just shy of the old November 5 08 high of 1,008.50.  In many respects, yesterday was a very close cousin to the day prior until about noon, when it failed to rebound off the 991 support area and, instead, made lower lows into the afternoon.  As we updated intraday

Recall that yesterday’s point of control at 991.00 had strong support and bulls were able to reverse price from it.  A break below signals a reversal from the bullish sentiment that has carried the week and has seen the major points of control hold. 

We didn’t get a material break below 991 as 990.00 was the low, and the trend of respecting higher value areas remained intact.

Big picture:  The FRNY’s permanent open market operations (POMO) have been gaining momentum in the news lately—nothing in the mainstream media that we have found, but increasingly, astute independent economists and bloggers are focusing attention on the operations.  Chris Martenson reports:  

And now it turns out that 47% (!) of the bonds that were taken by the primary dealers in [last week’s 7 Year] auction have been quietly bought by the Fed and permanently secreted to its balance sheet.

Recall the non-primary dealer interest was low in the 2 Year and 5 Year and that (we believe) demand was merely being saved for the 7 Year.  In what can be described only as a pyramid scheme, it is clear that the primary dealers are being allowed to offload their recent Treasury purchases through POMO operations, sometimes on the settlement date, meaning the debt was not in their hands for a full 24 hours.  As Brian Brenton writes:

It makes you wonder if the Fed is not encouraging primary dealer participation in these auctions by making it abundantly clear that the Fed will absorb a sizeable portion of their inventory quickly, while still assuring dealer profits. This is about as close as it gets to the Fed lending directly to the Treasury, without actually doing it.

It was the March 18 09 FOMC Announcement that paved the way for POMO, allowing $300 M and six months for the operations.  It is increasingly clear that POMO is a necessary evil to maintain Treasury auctions.  The ramp job in equities is a side effect of the dealers leveraging that capital and flooding the markets with it, and must irritate Bernanke to no end as higher equities are themselves reducing foreign interest in the Treasury auctions and causing long term yields to become dangerously close to reaching levels that, once broken, will end up spiraling out of control. 

We updated yesterday,

As we speculated earlier in the week, the FRNY has, for the third week in a row, announced on Thursday that the next day (Friday) it will be conducting permanent open market operations on Agency securities (Fannie/Freddie).  The amount of Agency POMO is usually about $1.5B, less than regular POMO.  However, this will make an unprecedented five days in a row (including Monday and Tuesday’s scheduled operations) of liquidity dissemination that can be leveraged 100 times or more in the markets.  With $7.5 B yesterday, $7.00 B today, we could easily see $30 B of leveragable capital hit the markets by Tuesday.  Clearly, the FRNY is coming out with guns blazing and we should have a volatile week into Wednesday’s FOMC Announcement. 

In light of the Martenson and Brenton articles, this 5 day POMO frenzy could be clearing the decks at the primary dealers for next week’s 10 and 30 year auctions on Tuesday and Wednesday.  Bernanke is in a very tight spot as (1) he will likely need to announce renewal or non-renewal of the quantitative easing program (POMO), (2) he does not want the next top in equities to be too close to the FOMC announcement as he is seeking re-nomination, (3) if we don’t get an equities correction soon to relieve pressure on long term yields, he could instead preside over a major Treasury market dislocation.  Things, in general, are looking up for Larry Summers, who would be happy to have his job, and we would not be surprised if this historic rally that began in July were part of a Bernanke hit job—forcing him to play his hand at the upcoming FOMC meeting.

On to NFP:  We set forth four scenarios yesterday, and it looks like unlikely #3 is now playing out. 

 (1) Equities and bonds both finally correct off a poor NFP report tomorrow.

(2) NFP doesn’t generate much volatility (like last month) and both equities and bonds tread water into the FOMC Announcement.

(3) Over the next few days, there is another material spurt up in equities with a return in the 30 Year bond to lows in the 112 area, and then a double bottom in bonds into the FOMC Announcement that then sees equities correct and bonds begin a multi-week rally.  This requires a move of 4 ½ big bond points and, for this to occur, we need to see a strong move through support at 114’30 (swing low) from tomorrow’s NFP report (which would have to greatly exceed expectations), with the FOMC Announcement generating the bullish news for bonds (and bearish for equities).  If Bernanke wants to kill the stock rally, all he has to do is hint at tightening.

 (4) Equities continue to break to new highs after the FOMC Announcement, long term yields break to new highs above 5%, and gold priced in US Dollars breaks 1,000 convincingly.

Trading Today:  As we write, NFP has greatly exceeded expectations and, as we would expect, equities and long term yields are materially higher, with the 30 year having tanked.  The ES has found some resistance at the daily R1s, but should be able break to material new highs if it can clear in early market action.  We’re not outright bearish unless and until the market corrects back down to 994.25.  A word of warning to the bulls is that these premarket spike highs often presage…

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Yesterday:  Examining yesterday’s price action in the ES, we had an early test of the next lower [market profile] value area and bounced within a tick of its point of control at 991.00 (green line by yesterday’s low in the support and resistance chart on page 3).   This area was rejected and the ES was able to test its opening area into the late afternoon, but then reverted to the 998.50 point of control.  When markets continue to reject lower value areas in favor of higher ones, this is bullish.  The only thing bearish was the inability of the ES to rally in the close after the $7.248 B in permanent open market operations (POMO) capital that had been released by the Federal Reserve Bank of New York (FRNY) earlier in the day.  Yesterday, we wrote

“With equities overextended, having had no meaningful pullback since the July rally began, the close today will be an excellent test of whether or not it can continue, or whether the continued capital infusions by the FRNY are in vain (at least temporarily).”

Big picture:  The FRNY announced the upcoming schedule for its POMO operations and there are now two scheduled next week for Monday and Tuesday, sandwiched conveniently between the Employment Situation (NFP) report tomorrow and Wednesday’s FOMC announcement.  In addition, we have the closely watched 10 year and 30 year auctions on Tuesday and Wednesday, respectively.  Demand on the long end of the curve is most important to the Treasury as it is trying to average up the maturity of its obligations.  Tepid to poor demand can send yields soaring, which it wants to avoid at all costs.

The next five days of trading into next Wednesday are exceptionally important and will probably decide the fate of this rally.  Though we lean strongly toward an equities correction to keep long term yields in check (temporarily), the FRNY is shouting loudly that, bonds be damned, it will get its S&P 1200.  Can we have both?  We don’t see how.  So, we see four possibilities:

(1) Equities and bonds both finally correct off a poor NFP report tomorrow.

(2) NFP doesn’t generate much volatility (like last month) and both equities and bonds tread water into the FOMC Announcement.

(3) Over the next few days, there is another material spurt up in equities with a return in the 30 Year bond to lows in the 112 area, and then a double bottom in bonds into the FOMC Announcement that then sees equities correct and bonds begin a multi-week rally.  This requires a move of 4 ½ big bond points and, for this to occur, we need to see a strong move through support at 114’30 (swing low) from tomorrow’s NFP report (which would have to greatly exceed expectations), with the FOMC Announcement generating the bullish news for bonds (and bearish for equities).  If Bernanke wants to kill the stock rally, all he has to do is hint at tightening.

 (4) Equities continue to break to new highs after the FOMC Announcement, long term yields break to new highs above 5%, and gold priced in US Dollars breaks 1,000 convincingly.

With 4 so damaging to the Treasury’s ability to issue long term debt and posing the risk of long term yields spiraling out of control, it’s by far the lowest on our probability scale.  1 and 2 are about equal, and 3 a bit lower.

Trading Today:  As we write, the ES has advanced to the daily R1’s and made new highs, nearly reaching our long term 1008.50 upside target.  However, it is in a potential reversal area, which bulls will need to…

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We could republish much of yesterday’s column in today’s report because not much has changed.  As we noted post-close yesterday, the daily market profile points of control at 998.50 for Monday and Tuesday are identical and, as expected have served as support overnight (low 999.00). 

Today and Thursday are POMO days, or those days on which the Federal Reserve Bank of New York conducts permanent open market operations and floods large institutions with leveragable capital.  Though these days usually have a low in the hour closing at 1:30 pm EDT and a tape painting effect, the second day of a back to back POMO set does not necessarily have a bullish or bearish edge.  Also note that we can have a paint the tape close on a net down day.  With equities overextended, having had no meaningful pullback since the July rally began, the close today will be an excellent test of whether or not it can continue, or whether the continued capital infusions by the FRNY are in vain (at least temporarily). 

As we write, the Challenger jobs report came a bit worse than expectations and the ADP Employment report came in good as expected, which pushes up expectations for Friday’s Employment Situation report on non-farm payrolls (NFP).  As shown on the chart on page 2, NFP days are frequently volatile (with the notable exception of last month’s) and tend to occur around turning points in the market.  Unless we have an extraordinary correction into Friday morning, the likelihood is that the turning point will be to the downside and will coincide with the needed support next week in Treasuries (at the expense of equities).  Another possible situation is a minor correction into Friday morning with a retest of highs that day resulting in a double top formation.  As the 30 year and 10 year are testing strong support now, we posit this is the more likely situation, which would make the overnight high of 1006.50 a temporary high.  For confirmation, however, the ES needs to close below 991.00 and ideally get below 996.00 early.  Otherwise, we will likely see new highs into early Friday.

Today is also an important day for the Treasury markets, as the department will release its funding intentions for the next quarter and the amounts of the all-important Treasury auctions in the 3, 10 and 30 year scheduled for next week.  The trend has been for the amounts to increase and, if they do not, we would take this as a sign that the Treasury is a bit worried about finding support.  However, this would be short term bullish for Treasuries and, with the 30 and 10 year at support, we would not be surprised for either this to occur or for equities to correct, either one of which would put in a needed temporary bottom in Treasuries.

In the ES, there is much overhead resistance into 1,013.50.  So, if we were to get a strong directional day up, it would need to be…

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