What is Pomo

In the spring of 2009, the New York Federal Reserve Bank, a component bank of the U.S. Federal Reserve Bank, announced it would initiate what was to be called Permanent Open Market Operations which has since been abbreviated to POMO by market commentators and investors.

The purpose of the Permanent Open Market Operations is to counterbalance inflows and outflows from the Federal Reserve Bank. By adjusting its balance sheet of assets and liabilities, the Federal Reserve Bank can also maintain the available amount of money supply which in turn affects market liquidity i.e. how much money is in the economy.

To illustrate how a Permanent Open Market Operation transaction would work, the relationship with ‘primary dealers’ is an important consideration. Primary dealers are the counterparties that agree to help facilitate the Federal Reserve Bank’s objectives by either buying or selling financial securities from the bank.

Three of the POMO primary dealers are Barclays Capital Inc., Goldman Sachs & Co, and Deutsche Bank Securities Inc. For example, on September 9, 2010 the New York Federal Reserve Bank purchased $1.35 billion in financial securities from one or more of its primary dealers. Securities bought and sold in such transactions may include financial instruments such as mortgage backed securities, and government bonds.

When a Permanent Open Market Operation purchase is made from primary dealers, money enters the financial system via these banks. These banks may in turn reinvest this money in a way that influences the stock market. Since primary dealers may also be investment banks that serve as ‘market makers’, they potential to influence securities prices exists, and is contended to be present basis for stock market manipulation by some market observers.

To test whether or not the theory of market manipulation is true, one can contrast specific POMO transaction dates and observe market movements in indexes for those particular dates. According to the Federal Reserve Bank of New York, nine Treasury Coupon Purchases were scheduled between August 17, 2010 and September 13, 2010. Between August 17 and September 9, the Dow Jones Industrial Average approximately traded within the 10,000-10,400 range moving in both directions despite eight of nine purchases from primary dealers.

Another way to see if POMO transactions influence stock market values is to compare cash flows. For example, according to NYSE Technologies Market Data, on September 8, 2010, over $25 Billion in dollar volume was traded on the NYSE. Yet, if this dollar volume does not itself take into account leverage, the number could plausibly represent $250 billion. Now assuming net leveraged dollar volume for all U.S. exchanges is closer to somewhere between 1-25 trillion dollars, the POMO transaction is minimal with only $1.35 billion of cash inflow to primary dealers. Even if the amount is equally leveraged to $10s of billions as reported by Tyler Durden on Zero Hedge, the amount of financial influence might only range from around half a percent to 10 percent at best.

There is room for speculation as to whether or not the Federal Reserve Bank of New York does have the capacity to move market indices such as the Dow Jones Industrial Average on a consistent basis. At the least, it would seem a large cooperation would be needed from the use of  additional funds made available through primary or other dealers. Moreover, the technical indicators of the market suggest a trading range for the DJIA for most of the period of the aforementioned POMO purchases despite the uni-directional flow of money into the primary dealers facilitation. Further review of the technical indicators however shows significance price movements before and following the initiation of the Federal Bond Purchasing Program indicating a possible correlation.

Sources: Date of record (September 9, 2010)

1. http://bit.ly/4widM0 (NY Fed)
2. http://bit.ly/apRffP (Zero Hedge)
3. http://bit.ly/ctJP2m (NYSE Market Data)