JP Morgan Admits That "QE Will Offset Almost All Of Next Year’s Government Deficit"

Tyler Durden's picture

There was a time when it was nothing short of economic blasphemy and statist apostasy to suggest three things: i) that the Fed's canonic approach to monetary policy, in which Stock not Flow was dominant, is wrong (as we alleged, among many other places, here); ii) that the Fed is monetizing the deficit, thus enabling politicians to conceive any idiotic fiscal policy: the Fed will always fund it no matter how ludicrous, converting the Fed effectively into a political power and destroying any myth of its "independence" (as we alleged, among many other places, most recently here in direct refutation of Bernanke's sworn testimony); and iii) that by overfunding bank reserves, the same banks are left with one simple trade - to frontrum the Fed in its monetization of the long-end, in the process destroying the bond curve's relevance as an inflationary discounting signal, with more QE, leading to tighter 10s, flatter 10s30s, even as the propensity for runaway inflation down the road soars, in the process eliminating any need for the massively overhyped, and much needed to rekindle animal spirits "rotation out of bonds and into stocks" trade (as we explained, first, here). Well, that time is now officially over, with that stalwart of statist thinking, JPMorgan, adopting all of the above contrarian views as its own, and admitting that once again, the Fed and conventional wisdom was wrong, and fringe bloggers were right all along.

And while we recreate the piece in its entirety below, here is the punchline:

Since the Lehman crisis, the Fed has been purchasing Treasuries and Agencies at a $500bn per year pace. This flow, which is equivalent to around 3.5% of US GDP, has offset more than a third of the government deficit since the end of 2008. In other words, QE purchases meant that the QE-adjusted government deficit has averaged 5.8% of GDP since the end of 2008 instead of 9.3% for the actual government deficit. This week’s Fed announcement means that this QE flow will double from a $500bn pace currently to $1tr. Coupled with a projection of a lower government deficit next year, to around 6% of GDP, this means that QE will offset almost all of next year’s government deficit.

Who knew that in the internal JPM thesaurus, "offset" was equivalent to "monetize"... But we'll take it.

From JPM's Nikolaos Panigirtzoglou:

Flows & Liquidity: QE's Stock Effect

  • The Fed announced this week an extension of operation twist bringing the total amount of net bond purchases expected for next year close to $1tr.
  • The excess reserves are likely to increase by the same amount, from $1.4tr to $2.4tr, adding 70% extra liquidity into the banking system.
  • This extra liquidity has the potential to suppress bond yields in addition to the traditional demand effect of QE. This demand effect is well documented and understood. As the Fed buys Treasuries and Agencies it offsets government supply, exerting downward pressure on yields.
  • What is often overlooked and surely less well understood is the liquidity effect of QE. What is this liquidity effect?
  • As we highlighted in F&L Oct 5th, QE by itself does not affect the overall supply of collateral, as government bonds are replaced with reserves. But it  does affect the relative pricing of collateral by creating a shortage/expensiveness of government bonds vs. cash (reserves). QE is a good example of the distinction between collateral scarcity and collateral shortage. QE does not create a shortage, as the overall supply of collateral is unchanged, but it does create scarcity by making one form of collateral (government bonds) more expensive relative to another (zero yielding reserves).
  • The most important difference between the liquidity effect and the demand effect is that that the former operates via stocks while the second operates via flows. As the Fed buys Treasuries and Agencies both effects are in operation.
  • The Fed offsets government supply via bond purchases and at the same time the stock of zero-yielding excess reserves rises relative to the stock of government and government related bonds held outside the Fed.
  • If the Fed were to stop purchasing bonds on net, the demand effect would disappear but the liquidity effect would remain. For as long as the Fed maintains its stock of QE and its zero-interest-rate policy, the stock of zero-yielding excess reserves will continue to affect the relative pricing of government bonds.
  • Since the Lehman crisis, the Fed has been purchasing Treasuries and Agencies at a $500bn per year pace. This flow, which is equivalent to around 3.5% of US GDP, has offset more than a third of the government deficit since the end of 2008. In other words, QE purchases meant that the QE-adjusted government deficit has averaged 5.8% of GDP since the end of 2008 instead of 9.3% for the actual government deficit. This week’s Fed announcement means that this QE flow will double from a $500bn pace currently to $1tr. Coupled with a projection of a lower government deficit next year, to around 6% of GDP, this means that QE will offset almost all of next year’s government deficit.
  • What about the liquidity effect? The liquidity effect is also set to intensify next year. To quantify this liquidity effect we follow the approach by Krogstrup-Reynard-Sutter “Liquidity Effects of Quantitative Easing on Long-Term Interest Rates”, January 2012. This paper proxies the liquidity factor using the ratio of excess reserves divided by the stock of government securities held outside the Fed.
  • Excess reserves should rise by $1tr, to $2.4tr by the end of 2013. At the same time the stock of Treasury and Agency bonds should rise by around $675bn (net supply of $900bn for Treasuries and shrinkage of $225bn for Agency debt and Agency MBS). This means that the stock of government and governmentrelated bonds held outside the Fed will likely decline by $375bn ($1tr of QE purchases minus $675bn of net issuance for Treasuries and Agencies).
  • As a result, the liquidity effect ratio, i.e. the ratio of excess reserves divided by the stock of government securities held outside the Fed, is set to rise from 10% currently to 17% by the end of 2013.
  • What does this mean for Treasury yields?
  • We have tried to quantify the impact of the government deficit and other factors on bond yields in the past by fitting a regression model using data going back to 1959 (see “A Fair Value Model for US Bonds, Credit, and Equities”, Panigirtzoglou and Loeys, Jan 2005). The model values the 10-year UST yield as a function of long-term inflation expectations, the real Fed funds rate, inflation volatility, and three major components of the demand for  capital in the US market, the government, corporates, and emerging market issuers in dollars. We measure these by the government deficit, the  corporate financing gap (i.e. the difference between capex and cash flows), and the EM current account balance, all as a % of US GDP. Higher deficits by governments and corporates push up yields as overall demand for capital rises. External surpluses of EM countries push US yields down because of the repayment of dollar-denominated debt and the dollar asset accumulation by their central banks.
  • As explained above, we capture the QE flow effect by subtracting bond purchases by the Fed from the overall government deficit (as % GDP). We capture the liquidity effect by the ratio of excess reserves divided by the stock of government securities held outside the Fed. In theory, these two effects depress bond risk premia, i.e. term premia.
  • Beyond bond purchases, the Fed is also affecting bond yields via its communication. That is, via its communication the Fed affects the path of expected future short rates. The literature has tried to quantify this affect via event studies. This is because, in theory, signaling should be mostly present at announcement times.
  • Given the difficulties that these event studies have with choosing the appropriate window around the announcement date, we instead prefer to proxy this signaling/communication effect more directly via Fed’s forward guidance. In particular, the variable we use is the time period (in months) over which the Fed has committed to keep rates low and is being constructed and used by US Fixed Income Research team, Terry Belton et al.
  • The coefficients of the 10y UST regression model are shown in Table 1 while the fitting errors are shown in Figure 2. The model has provided a good fit to quarterly averages of the 10-year UST yield over the past 50 years with an average absolute error of 57bp and R-sq of 86%.
  • All coefficients are statistically and economically significant, suggesting that both QE flow and QE stock effects are present. This is admittedly a mechanical exercise with imperfect proxies for QE flow, QE liquidity and Fed communication effects. But the model illustrates how important and persistent the liquidity effect of QE can be as the Fed continues to expand the stock of excess reserves next year. It also casts doubt to the idea, advocated by Professor Michael Woodford via his speech in Fed’s annual Jackson Hole conference, that the portfolio balance effects of QE purchases are minimal and that the Fed’s impact on bond yields stems almost exclusively from forward guidance.

* * *

Are these the first rumblings of mutiny on the Titanic, we hear?

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kliguy38's picture

DON'T buy that barbarous relic.......invest in fiat for your protection...while the dollar is whittled down to zero.

Muppet of the Universe's picture

I gotta set some shit strait here.  Now granted this is obv my opinion, so with grains of salt please.

first of all, if you are going to be jumping on predatory algos, don't use FB as your example.  FB first day was a MIRACLE, that it stayed above 25.  The related stocks that had followed fb's bubble, crashed so hard 1-3 months before hand, it sent chills into the spine of anyone who knew anything about what was going to happen to fb's ipo.  Bank traders lost billions defending what could have been the worst ipo opening in history by a margin of several hundred percent.  FB should have hit like 10 dollars.  Did you see what happened when hft traders got the opening hits from 45?  43 in micro seconds.

Second, the fiscal cliff is the same bullshit that always happens, only this time, the hard economy is going to begin feeling reality.  Begin.  So no, this doesn't mean the dollar dies instantaneously.  In fact many traders are very bullish on the dollar, in the immediate term.  Log term is another story.  What this means is that a year or two down the line, the hard economy will begin experiencing serious problems.  Jobless rates will likely continue to grow, deflation will become more of a problem, and the dollar's devaluation will be used combat the deflation.  Collapse is practically certain, and the cliff is simply a catalyst.  However, it becomes clear to us, that propper inflation and injection into wall street, will offset the financial class from panicking out of the market, and subdue deflation.  This is likely the thinking behind the Fed.  At the same time, inflation as a road to hyper inflation, will be put on the ice as money velocity slows.  Put on the ice, not stopped.  There is 1 kink in the works though, that I do not understand.  Buying the mbs market seems like the fastest way to increase money velocity, aside from starting up businesses that are successful.  I mean give the muppets an avenue to spend money, what better way than to have them trading houses.  So in that respect I am confused.  Now everyone hates bernanke.  But, in all fairness, he was hired to steer the economy into the ground, and crash land it carefully.  & that appears to be happening, with the sole objection and curiosity I have, why inflate housing again if money velocity is your enemy?

DoChenRollingBearing's picture

Even Barron's is calling it QE4...  They also bring in 10 "Wall Street Top Strategists" for their Outlook 2013.  

The bankers and politicians are beyond redemption.

Review of Barron's -- Dated 17 December 2012

DeadFred's picture

Everything Ben does is to help the banks. The banks are scheduled to start selling the backlog in spring. MBS purchases, ultra low rates and the threat of inflation is making pockets of the RE market turn red hot. A Bay Area broker told me last week he has never, ever seen the market so hot (and he's not a young man). Lots of good paying tech jobs in the area but move inland a few dozen miles and the RE market is as dead as the job market.

tango's picture

By "banks" I presume you mean the investment (not community) bank.  When folks say the FED is trying to enrich banks they are only half correct.  He is trying to throw them so much money they'll give away loans but the local now follow even more stingent rules.  My wife and I recently took a second on our home (5 yrs, 3.25%) to buy property and even with a credit score in the 800's it took weeks.

earleflorida's picture

give me a big 'Amen' brother!

lasvegaspersona's picture

like the Bible warns: when JPMorgan agrees with ZeroHedge ye shall see the end times coming...

something suspicious here as I have assumed that JPMorgan was the organ of bringing Fed policy to reality....maybe just one lost soul in the org that wasn't clued in?

willwork4food's picture

Agreed, as long as the bible says that. Somewhere. EOTs baby!

CPL's picture

Fetch me a martini and I'll pay you with this fist full of brightly coloured Romanian fifties.

Akrunner907's picture

To make the finances work, the top tax rate would have to go to 71 percent for those making over $250,000 a year. For those making $120,000 to $250,000, the tax rate would be 48 percent. For those making $32,800 to $120,000, the tax rate would be 39 percent. Those making less than $32,800, the tax rate would be 19 percent. That is the reality of the situation that the media will not talk about.

tango's picture

And then there is the element (supported abundantly by recent evidence in numerous states)...When rates are jacked the amount drops the second and succeeding years.  Folks become create, move assets, locations, sources and investments.  These constantly moving rates are so destructive because of the uncertainty they engender.

Anasteus's picture

Nikolaos Panigirtzoglou is a Greek name... oh, shit, got it!

It's not JP Morgan who took over Greece, it's Greece who took over JP Morgan.

Anasteus's picture

•  The price of silver continues to go down despite we've been out of metal for a longer while. The trend is masked by high premium paid on Comex to avert delivery, which works fine so far. It, however, still requires cautious supervision to prohibit a possible Comex default.

fonzannoon's picture

Mutiny? Nah. Next year is all squared away. One less thing to worry about.

Silver Garbage Man's picture

I'm not worried, I've got my silver life jacket on.

Jason T's picture

"the federal reserve will not monetize the debt"

CPL's picture

True, it will not monetize the debt.


It will create an investment vechicle derived from CDO's and slushed 401k's, leverage it, undersign a pension overhaul into law, then pull the ass end out of anyone with a pension plan.  Because that's the plan, everyone is going to switch places until the optics are that both rich and poor live a crappy life.



asteroids's picture

What it means is that NO ONE in the civilized world wants US debt anymore. The FED must buy all of it. Think of that for a minute. The US is dead, it just doesn't know it yet.

HurricaneSeason's picture

Households have been buying the deficit for the last year or two. There just wasn't enough left in the cookie jar to keep buying a trillion dollars a year. I think I understand how the bonds work, now. Since the Federal Reserve is buying $1 Trillion a year, that helps liquidity and keeps interest rates very low.

CrashisOptimistic's picture

If you bought long term fixed income (aka bonds) 1 January 2012, you're up 13% YTD, per .  That's what happens with the 10 yr drops 30 bps over that time. 

Given that the Fed will now buy MORE bonds than last year, there is no reason to presume another 14 or more % can't be grabbed from perhaps a 50 bps move to 1.2%.  Then in 2014, perhaps from 1.2% to -2%.  

Each of these moves is profitable for bondholders.

Given that the governments of the world are deciding all these things by decree, one can be pretty sure that special tax laws won't be structured to risk this lowering yield on that 16T of debt.  

In contrast, if gold were of significant numbers to the economy, you could be pretty sure transaction taxes on it would happen since it doesn't have any effect on the global economy.  It's therefore a very juicy revenue target, but . . . as I said, only if it had significant numbers, which it doesn't.  So there's a downside to wanting to see it grow.  There is risk to it growing.

fonzannoon's picture

If you bought red hat and juniper and AOL from mid 90's through 2000 you did awesome right until you got your ass handed to you. What year is it in the bond version....1999?

CrashisOptimistic's picture

My recall is the bond bull is 30 yrs going, now.

The reason history doesn't matter for this matter is that we have an explicit reality.  The infinite source of money is the bidder on bonds.  They have specifically said so.

When that stops, you sell.  No indication they are going to stop.

fonzannoon's picture

No thanks. I will sit this one out. The day it "stops" you lose everything. If they push too hard they hyperinflate. Why bother thinking you can time it?

CrashisOptimistic's picture

You don't have to time it.  They tell you exactly what they are going to do and when.

When they say they will not buy 1 trillion in bonds, then you're out.  Until they say that, they are infinite money bidding on your asset.  

fonzannoon's picture

Are you being serious? When was the last time the market reacted after an announcement? You don't think the fed turning off the spickets would be known well in advance by the PD's etc? You will be sitting there scratching your head saying"well this is odd....there is no news...yet I am getting my ass kicked" for a long time before that announcement was ever made public.

CrashisOptimistic's picture

Well, there is always the conspiracy insider theory in play.  

The overall point of this is 14% for better reasons than you can get elsewhere.

They won't tax this.  Taxing it hurts them.  They can tax gold transactions in a microsecond if gold ever mattered.  They are dictating markets by decree (meaning there is no market).  You can't get a better non taxed underpinning than the source of infinite money that issues the decrees.

willwork4food's picture

Personally, I prefer to just invest in beer & cigarettes. WTSHTF, they will be hot commodities.

fuu's picture

"conspiracy insider theory in play"


Libor, HSBC, MFG, it's just so theoretical!

rbg81's picture

A lot of people say that hyperinflation will not occur as long as this extra $$ sits in bank vaults.  But, if you really think about it, that is NOT happening.  The money is being given to the Government to spend.  So it IS making it into the real Economy through transfer payments.  The only part of it going back into the "Bank Vault" is the interest paid on the debt.

So why is hyperinflation not occuring?  Simple.  Because ALL the Central Banks are following the same strategy under one guise or another.  The ones really taking it up the ASS are the oil producers or, really, anyone selling commodities or products at prices which have not been hyperinflated.  At these entities may be doing it at the point of a gun.  The proverbial "gun" may be the utter fucking chaos and fear that would result from REAL MARKET FORCES being unleashed for the first time in at least four years.  That scenario scares most of these guys worse than a full-scale Zombie Apocalypse.

tango's picture

Excellent post!! The question of inflation, hyperinflation, if/when it comes, etc is one that seems to dominate ZH type groups.  I'm not completely sure that the global central banks are what is preventing prices rising faster but you hit it on the head with commodities.  Their costs cannot be finessed and there is no way the powers that wannabe will ever return to market driven pricing system.  Almost assuredly, we will have more nationalizations before the end.

hairball48's picture

It all works...until it doesn't.

tango's picture

You are absolutely correct.  When the "market maker" is the FED you can bet that they will get the market to respond to whatever they want.  While I still think we are utterly broke and will collapse within my lifetime, I have stopped listening to the doom next week crowd.   The prestiege of the dollar is still supreme globally and until that changes, we will go on acting like idiots.  I am still stunned that many refuse to make money (as you did) but instead wait and hope for the end. 

I have waited 3 years, on the edge of a bond hedge fund (downside) but at last my financial advisor said almost exactly the same thing you did - go long for now.  It seems so...irrational and yet with the FED the only player in town, the path is fairly clear.



Currency is Debt's picture

JP Morgan Chart, 2007-2012

JP has been propped up by the taxpayer. Although this bank and Goldman and even it seems Wells Fargo are heavyweights. They have way outperformed many other big tptf banks. JP and Goldman were caught less aware shall we say than others. But still without the taxpayer contribution this stock could not trade at its current price. 

Compare to Bank of America

Bank of America Chart, 2007-2012


debtor of last resort's picture

Don't bite the hand that feeds you JPM.

Atomizer's picture

Don't bite the hand that feeds you JPM | October 2012


Are you talking about the nugget of silver/gold that JP Morgan continues to use for remonetizing debt? Uncle Ben can offer new negative discount window rates. Beep, beep, beep.. look out bitchez, my truck is backing up. Beep, beep, beep.

davidsmith's picture

The only thing the statist/fascist/corporatist economy cannot control is social deterioration.  Instead, it leaps ahead to preserve the status of those deemed essential for preservation of the police state.  Increasingly, these are the people in the cities (which is why people are moving to cities--in order to be considered one of those people).  People in the suburbs will be left to rot--just look on American suburbs as abandoned Soviet industrial cities. 

The only reason there is an increasing emphasis on agricultural land (or any other commodity) is not some supposed increase in future demand, but rather, because the agricultural plant will be increasingly commandeered to supply the cities.  This is what happens when a society is considered to comprise only its leadership.  It's the Stalinist model: leadership uber alles.  Leadership is all--leadership is a self-perpetuating and self-referential concept.  Everything is sacrificed in order to preserve the leadership. 


Everybody knows this now, and everybody in America is scrambling to be part of this "leadership"--only participation in the leadership means survival.  Don't be caught out! 


fonzannoon's picture

LOL....where are you Lawsofphysics?

"Michigan State Treasurer Andy Dillon notified Governor Rick Snyder of the report's findings late Friday, just four days after the review began, according to a statement from the state Treasury Department.


"A preliminary review of the City of Detroit's finances has found that a serious financial problem exists in the city," the statement said.


The review paves the way for the state to take a deeper look into the city's finances, which in turn could lead to the declaration of a fiscal emergency that would trigger the appointment of an emergency financial manager"

max2205's picture

I'd be wary of bs from any MSTREAM BANK which doubts the Fed.

They never fight the fed. They are long and strong.

DUNTHAT's picture


fonzannoon's picture

There is a better chance that they wind down the Fed because JPM exposed them and JPM becomes the new "fed" and Dimon is annointed "awesome cheif of money guy" position.

FoeHammer's picture

lol 'annoited'. That really captures the essence of central planners.

Missiondweller's picture

When the Fed has an ever increasing % of the Treasuries, does this not mean the Shadow Banking System is decreasing? I wonder if this is a target of Fed policy to delever the Shadow Banking System?


Any thoughts from anyone? We've seen from previous posts that Shadow Banking is indeed decreasing. I not sure if I understand if this would be a good or bad.

dannyboy's picture

The fed is reacting to the deleveraging of shadow banking, not the other way around.

tooriskytoinvest's picture

Dollar Collapse In Progress: This Is The Biggest Debt Bubble In History And We Are In The Beginnings of The Death of US Dollar, Hyperinflation Will Happen By The End of 2014, In About Six Months A New Currency Will Be Issued, And The Next Crisis Will Be A Lot Worse!

hannah's picture

i cant tell you how many times i was told i was a fucking idiot when i said that the fed printed money(ie.e bought treasuries) and that the fed bought stock. it will be funny when we eventually find out that all the central bank gold has been sold 10 times over....oh and that pres hussein isnt really a citizen.

Troy Ounce's picture

...or that 911 was an inside job...or that Bin Laden lives in the US....

JR's picture

We’ve had a disaster with what Bernanke already has done;  why would it occur to him to not only do what he’s done but increase his effort?

Bernanke is not someone like John Locke who understood how economics and freedom work; he’s like a mugger whose plan to get the wealth is to grab somebody’s purse and run. That’s the plan.

And so Bernanke sees that we have some money left and his plan is to go after it! That’s not economics, that’s not GDP growth, that’s not high-wage incentive for labor to produce more as advocated by political economist, Adam Smith.

That’s just stealing.

And stealing has a way of ending.  It wipes out an economy, it wipes out incentive, it wipes out the integrity of a monetary system. People stop participating, particularly when they’ve been robbed; they can’t come up with any more wealth.

The central bank has come to the point where it’s using propaganda and threats and leverage against the government, against politicians, against foreign countries. Not only is it not working, it’s increasing the catastrophe. And so why would it occur to someone, when this is massively not working, to go ahead and not only do it some more but to increase it?

I can tell you why. The self-designated TBTFs who own the Fed are doing it on purpose. Their perverted purpose is to counterfeit the money and use it to steal money from the producers of the wealth, to subordinate the national economy to the counterfeit. It’s called theft. John Locke called it tyranny.

oddball's picture

What did some of those really, really old guys DO about tyranny?  Amerikakakak today?