An Unprecedented $660 Billion In Excess Debt Demand, And What It Means For Bond Yields

Tyler Durden's picture

When the BOJ announced two weeks ago the full details of its expanded easing program, which amounts to monetizing a whopping $720 billion in government bonds over the next year (a move which makes even the Fed's own open-ended QE appear like child's play in perspective), one thing it did was lay to rest any hope of a rotation, great or non-great, out of bonds and into equities. The reason is simple: while the Fed is en route to monetize $1,080 billion in UST and MBS debt in the current year, when there is just $760 billion in net US issuance, what the BOJ has done is add a bid for another $720 billion when Japanese net supply of debt is just $320 billion in the next 12 months. In other words, between Japan and the US, there is now some $660 billion in secondary market debt that the two banks will have to purchase over and above what their respective treasury departments will issue.

This means that the two biggest central banks are about to be perfectly price ambivalent as to what cost the monetize nearly two thirds of a trillion in debt: their mandate is to expand their assets at any cost, which means buying up debt from the secondary market at any price. The immediate consequence is that the best performing trade of 2011 and 2012 - frontrunning the Fed's purchase of the long end - is about to come back with a vengeance, as speculators buy up every piece of duration debt that is not nailed down, knowing full well they will be able to sell it right back to Bernanke and Kuroda in the future at whatever price they so desire.

The chart summarizing the massive disconnect between the monetization mandate and the net treasury issuance in the US and Japan, and showing the $660 billion delta, is below:

This is how JPM explains how much further yields will likely fall as a result:

We mentioned last week the displacement caused by BoJ purchases this year. The offset that central bank purchases provide to government debt issuance, represent the so called Demand or Flow Effect of QE. In fact, central bank purchases more than offset government bond supply this year. The BoJ is going to surpass government debt supply this year by buying $720bn of government debt vs. government net supply of $320bn, resulting in a net withdrawal of $400bn of government debt securities from bond markets. Assuming $85bn per month purchases for the whole year the Fed looks set to buy $1020bn of USTs and MBS securities this year vs. net issuance of $760bn, so a net withdrawal of $260bn from bond markets.


But there is another impact caused by BoJ purchases. The stock of excess reserves is likely set to rise sharply this year roughly in line with the amount of BoJ purchases, i.e. by $720bn, at the same time as the stock of government debt held outside the BoJ shrinks by $400bn. Similarly, the Fed looks set to inject close to $1000bn of excess reserves into the banking system at the same time as it withdraws $260bn of government securities.


This additional effect caused by the rise in central bank reserves, represents the Liquidity or Stock Effect of QE. We discussed this stock effect in a previous F&L on Dec 14th. The idea is that QE creates scarcity by making one form of collateral (government bonds) more expensive relative to another (zero yielding reserves). Given that the banking system cannot get rid of reserves, these zero yielding reserves, become the “hot potato” that banks and other investors try to pass to each other until the relative pricing is adjusted enough to remove the incentive for banks or investors to get rid  of these reserves.


And because the relative scarcity of these two forms of collateral depends on relative stocks rather than flows, the price effect would remain even in an environment where flows disappear. That is, even if central banks were to stop purchasing bonds, making the flow or demand effect of QE to go away, the liquidity or stock effect would continue to affect the relative pricing of government bonds vs. zero yielding reserves.


By how much is this Liquidity or Stock effect of QE affected by the BoJ policy? The change in the relative stocks of these two forms of collateral, excess reserves vs. the government debt held outside the central banks, in the case of BoJ at ($720bn - (-$400bn)) = $1120bn, comparable to that caused by the Fed ($1020bn - (-260bn))=$1280bn.


As a result, the liquidity or stock effect looks set to intensify this year. To quantify this liquidity effect across the G4 we use the ratio of excess reserves at the Fed/BoJ/ECB/BoE, divided by the stock of government securities held outside these central banks. Factoring additional QE by the Fed, BoJ, and BoE (we expect an extra £50bn of Gilt purchases by the BoE this year) and another reduction of around €200bn of excess reserves in the Euro area banking system due to further LTRO repayments, we project that this liquidity ratio will rise from 10% at the end of March to around 14% by year end. Again, under the assumption that bond buying by the Fed will continue at $85bn per month until the end of the year.


What does this mean for government bond yields? One simple way is to look at the changes in this liquidity ratio vs. changes in government bond yields. This is shown in Figure 1. Figure 1 shows there were two major episodes in the evolution of the liquidity ratio in recent years. The first major episode was in H2 2008, immediately after the Lehman crisis, when the liquidity ratio jumped from 0.5% to 5.0%. The second major episode was during 2011 and the first half of 2012. During these 6 quarters, the liquidity ratio rose from 5.5% to 11.0%.


Figure 1 shows these two episodes saw the biggest declines in bond yields over the past five years. During the first episode the government bond yield of our GBI Global index declined by 120bp. During the second episode the GBI Global index bond yield declined by 70bp. Given that the two episodes were accompanied by a similar 5% increase in the liquidity ratio, this suggests  there are diminishing effects to QE, i.e. each further 5% increase in the liquidity ratio exerts smaller downward pressure on bond  yields. It would be thus reasonable to assume that another episode of a 5% rise in the liquidity ratio for example should lower bonds yields by less than 70bp, perhaps by around 40bp or so.


With the caveat that it is difficult to separate the flow, stock or signaling effects of QE, mechanically this simplistic exercise suggests that a 4% increase in the liquidity ratio over the next three quarters could push bond yields lower by around 30bp (from March end levels of 1.75% for the GBI Global index yield).

To summarize: in the coming months, bond yields will continue to slide as more speculators realize that they can extract any price from not one but two central banks, now desperate to buy not only all net primary issuance but a massive $660 billion in secondary market UST and JGB demand. This means that with central bank balance sheets becoming ever more ridiculously large, a phenomenon which even the most clueless textbook economists will admit will ultimately result in runaway inflation, the yields on the primary instrument which in normal times reflects the threat of runaway inflation, the long bond, will continue declining, and signaling to an ever dumber and more centrally-planned market that there is not one iota of inflation on the horizon. Taking the thought experiment to its ludicrous end, we can visualize the Fed and the BOJ's balance sheets hitting infinity as nominal yields become negative.

Thought experiments aside, unless of course the Fed and the BOJ are determined on becoming the only bidders in both the primary and secondary market, this means that the weak hands will likely continue to puke their gold holdings. However, and much to the chagrin of SocGen, gold is and has always been an inflation hedge, and we, for one, are delighted to take every opportunity to rotate out of ever more diluted fiat paper into hard currencies (and assets). The reason is that inevitably the moment when the central bank wheels hit the road will come, and it will be not so much a question of imminent price reaction, but what the long-bond, which will suddenly find itself without central bank bidders, and thus ostensibly bidless, does. What it will do is collapse, sending long-yields exploding, and making up for years of faulty inflationary signalling. Ironically this may come at a time when the central bank balance sheets are indeed contracting. However, without them present as bidders of last resort, watch out below if one is long the 30 year.

It is at that point that all those long bond to gold algos will wake up, and finally see the event horizon which for four years had been hidden by the global central banks' coordinated attempt at centrally-planning all asset levels.

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j.tennquist's picture

I'd buy the 660 billion in slack myself but I'm still long Beanie Babies. 

toys for tits's picture

I'd do it as well, but I just took my family out to lunch ... at McDonalds.

j.tennquist's picture

Oh man, nothing says love like the Super Value menu!

knukles's picture

BTW I just heard about the reason for the predident and banker meeting in Worshington.  The predident wanted to make sure the bankerthieves were comfortable that JacktheLew was as competent as Timmah.
So he kept him out of the room as an example, in exchange for more campaign contributions....

debtor of last resort's picture

The reason was getting rid of the Bernank.

knukles's picture

Oh, so that's why JacktheLew was quoted as saying; "Who?"

Actually may be the truth...
We sure didn't have any Volckeresque Saturday Night Massacre this weekend and Benny did say he'd not be going....

And so he asked for nominations for any people who were or currently are at Goldman for consideration...

markmotive's picture

If America followed Japan's path, interest rates could remain ultra-low until 2027. If Japan can do it why not America?

Banksters's picture

Backed by the full faith and credit of the US.






Sad but true.   Everyone keeps talking about freedom, where?   

LawsofPhysics's picture

If only there was an alternative to all this fiat, oh wait....

francis_sawyer's picture

'Monetize' joobux till it hurts...


Fuck ~ From my perspective, the paper content of joobux makes a decent 'weed block' & otherwise puts a nice barrier atop a nutrient rich worm farm underneath [which rivals tried & true BURLAP]...

I'll continue to publish my findings if anyone is interested...


JUNKS from the jew worshipping Monsanto crowd coming in 5...4...3...2...

WhiteNight123129's picture


Exactly right, the other issue is that while there is a "demand" created for bonds, there is a supply created which will chase anything including stocks.

God forbids that this base money starts to panic about its own over-abundance as mentioned by Koo, Soros, Bass and others...


LawsofPhysics's picture

Correct. In an honest system of exchange, ineterest rates would rise and fix the concern of over supply as the furgal/successful people would be rewarded and more money would go towards interest (and reward those who respect capital and resources).  But I digress, the underlying structural issue is 7+ billion people (and growing) all competing for a better quality of life with the same available resources (not growing).  Sorry, it doesn't work like that.

terryfuckwit's picture

Silver gold and bit coin bitchez

LawsofPhysics's picture

"Silver, gold, lead, and brass" - Fixed.

you enjoy myself's picture

well i guess Timmy has got to get to work then.   the best part of the central bank lunacy over the last four years is that, when you say:

unless of course the Fed and the BOJ are determined on becoming the only bidders in both the primary and secondary market

it strikes me as more likely than not to actually happen (or they'll at least die trying).  they can't stop now.

ekm's picture

This is a reminder to everybody who think that the Fed prints money.

The Fed does NOT and I repeat, the Fed does NOT print money.




It is illegal for the Fed to create money out of nothing. Congress only creates money out of nothing.


Hence, as I've been saying over and over and over, Flow matters, but Stock also matters, since there's not much left to buy.


francis_sawyer's picture

ekm ~ Stop with this shit...


Who the fuck cares who 'TECHNICALLY' monetizes?...


It's a leveraged DEBT BASED system called "fractional reserve" [a concept created by jew moneychangers]... The first goddamned motherfucking thing they did after it's implementation was to get the US involved WWI, to get the debt train as well as the propaganda train rolling, [& that idea has only been improved upon ever since]...

It's a system designed to create the largest amount of debt possible, for the longest period of time possible...


When people finally cut with all the crap & realize that, then we move forward... Until then?... We just get a lot of ZH page hits [with HuffPo transfers junking francis_sawyer comments]...



ekm's picture

I'm trying to explain how it's been working so far, thus concluding that it is about to collapse again, due to LEVERAGE.


Since congress won't offer collateral any longer, it's done. The Fed can't monetize something that does not exist.


The system needs a catharsis, at least 3 times Lehman, Lehman Tripple.


(side note: I never vote down any comments)

francis_sawyer's picture



I've enjoyed reading your musings on this subject... But whether they're true or not, NOTHING of what I just said above changes...

IOW ~ It's still a leveraged... PAPER... DEBT BASED SYSTEM... As such ~ It'll collapse when they want it to collapse... If 'they' happen to actually fuck that up, [which is possible &, it seems, is part of your premise], then it still doesn't change very much... Instead ~ It'll only, slightly, alter the beneficiaries & hitherto allocations & reapings of the few who survive the aftermath [& presume themselves, in this moment in history, to be KINGS]...

It's a fucked up world & you're NOT in the club...

Grow some spinach & corn... Get your fingernails dirty... Eat well & be happy... [& hopefully learn to brew & distill some 'spirits' along the way]...

ekm's picture

There is fighting inside the club, and it's deadly.

francis_sawyer's picture

Now... THAT... I agree with... [There's INFIGHTING going on at the moment]...


I've published this... in comments... many times... WHEN IT BECOMES JEW VS. JEW... ALL HILARITY ENSUES... Most, here, are so packaged by their own politically correct wanna fit in-edness... That they don't know what the fuck I'm talking about...

Still... My imagination lingers & leans towards LOGICAL & OR HISTORICAL outcomes... So... NOTWITHSTANDING INFIGHTING... What's going to emerge is the 'bonfire'... Frankly ~ It goddamn motherfucking doesn't matter what happens [to me]... I'm hedged either way... & HOW?... Easy... Because I don't tie my EXISTENCE [neither physical, nor spiritual], to their architecture...

Goodnight... Sweet Dreams...

LawsofPhysics's picture

Bullshit.  These fuckers (moneychangers, paper-pushers etc.) will simply use the bad paper as "collateral" for the "new" (bad) paper, just like europe.  Nothing, I mean nothing, will change until the supply lines break, the EBT cards stop working and everyone gets to find out just how trustworthy their tribe is.  History is very clear on this.  My guess is countries with disciplined sheep will be sent to a war first.  Guessing who's backyard it will be in now is akin to determining where a cow will shit in the field now.  Not sure where, but you know things will get messy somewhere soon.

ekm's picture

Supply chains already broken.

Timing of events is UNPREDICTABLE.


I don't think congress will release more paper since supply chains are fucked up already.

LawsofPhysics's picture

Bullshit.  85 billion per month, indefinitely...  plenty of bad paper getting released.  Moreover, if the EBT cards are working and Dancing with the stars is still on.  Shit's just fine in the city.

ekm's picture

In communism we started having food stamps in the late 70s but it didn't collapse until 1990.

That was full communism when people believed that the gov will fix it, everybody.


USA and the West is sliding into totalitarianism, but we're not there yet. I do not think that we're going full Stalin.

The very existence of Zerohedge is very comforting to me.

fonzannoon's picture

ekm they just got one of the largest cities in this country to hide in fear under their couches because some 19yr old kid was running around town. Millions of people locked their doors and were petrified. Then, after the most heavily armed police I have ever seen launched a massive war on an 8 foot boat and dragged that kid out, those 8 million people ripped their shirts off and downed beers and chanted and screamed "This is our city!!!!" from the roof tops.

This is totalitarianism with a hefty side of idiocracy.

francis_sawyer's picture


ekm's picture

There's a lot worse that that. If you think that's totalitarianism, you ain't seen nothing.


Your reaction makes me think that people are waking up. 

It was Benghazi coverup, now it seems we're going to have the Boston coverup. Let's see.

reload's picture

Supply chain stress example: I can not get letters of credit acceptable to UK banks from would be Spanish importers of my fertiliser products. I hear German manufacturers have pulled the plug also.

fonzannoon's picture

KInd of on topic but...I get that it is a big deal that the Bernak is skipping Jackson asshole this year. But are we really to believe that he is skipping it because the fed plans to taper off QE right about that time, and Bernank is too much of a puss to show up and make the announcement? Really?


reload's picture

More likely he is golfing with john corzine & Barry o

ekm's picture

If you pay attention to his interviews, he's getting sicker and sicker. His lips keep shaking.


At leaset Greenspan could lie to the audience without a blink of an eye, whereas Benny gives it all away.

Next chairman will have to be somebody that can a great actor.

Urban Redneck's picture

From Spanish Commercial Banks or ECGD? (not that either one isn't problematic)

reload's picture

ECDG would work I think, but it is designed for bigger, interbank transactions.  Shipping product to regional distributers who just have facilities with regional banks or Cajas is the issue. Of coarse the distributers will give credit to their customers, so it looks like a classic case of 'no free cash flow'  and they no longer have access to acceptable credit, putting up the type of collateral that a bank like Santander would require is  proving problematic. I think things there are getting serious, i am visiting very soon anyway so will learn more.

ekm's picture

RELOAD, thx for your feedback from the battlefield

Urban Redneck's picture


I generally use ECAs for sub-components of larger project finance packages- so the paperwork is different, but the math should be the same.  Most of my customers are non-rated borrowers in jurisdictions where the sovereign is paying north of 6% on treasury bills- so they need credit enhancement for a NY/EU/UK bank to even consider lending, and the local markets are cost prohibitive for anything that isn't close to sovereign.  If my memory serves ECDG has published "desired/ideal/target" loan amounts that it seeks to provide coverage for, but a smaller amount isn't necessarily a problem (unlike a larger amount) and at the end of the day- their job is to facilitate UK exports and help generate UK taxes.  

With practice- it's a quick process and winds up saving time on my end because of a quicker acceptance when I finally call my banker.  The interest expense might queer the deal if you move out the curve.  For just-in-time/net30/60/90 it should work out, but for channel-stuffing or if the distributor's customers are unexpectedly frozen out and inventory can't be moved, then ECDG would stop being an option, but it's worth giving them a call and exploring their options, (some of them do come off as the unholy spawn of a banker and a government bureaucrat though).

Either way - it sounds like a cool breeze is blowing through Banker Hell and Spain would be full-banana if not for the euro (which should help to keep coverage costs down with any ECA)


EDIT: I just went to their website to compare what "they say" they will do versus what I 've seen them do- and now even I'm confused.  I found their note for Spain "We are prohibited under European Union law from supporting business with a horizon of risk of less than 24 months."  The last time I checked- Greece was in the European Union, yet the Greek country cover page is littered with cryptic "Contact Us" messages for any terms.  If you can reach someone who focuses on the intricacies of Intra-EU trade at ECDG  they might be able to direct you to a private ECA/lender who could help with your precise situation- or explain their magical ability to dictate that Spain really isn't Greece (yet)- and whether they have another rabbit in the hat queued up for Spain.

EDIT: I pulled up Ghana since it's an ex-colony and I have experience there- and I almost spewed coffee on the monitor when I saw 150-250 MILLION pounds.  Your obstacle isn't the "market risk appetite" it's the bureaucrats and their regulations. 

Urban Redneck's picture

Zurich- but most of my business is exports from the US and Germany (and to lesser extent Italy) to West Africa.


DoChenRollingBearing's picture

@ reload 3481309

LCs being denied (UK - Spain) is worrying, particularly because Spain is within Europe and "a developed country".  I follow bits and pieces of international trade closely, although we pay 30% in advance and the balance on "cargo ready" in Korea, Japan and China.

The kind of friction in the trade system you identify is ominous.

ekm's picture

Every government decision has 3 steps:


1) Advisory (Federal Reserve, FBI, CIA etc)

2) Decision ( White House, Congress)

3) Execution ( Federal Reserve, FBI, CIA etc)


This process has always been like this, it is like this and it will always be like this.

It has never changed and never will


White House occupants and the House Committee covering the Fed, FBI or CIA or anything are supposed to know what they're doing, but they don't. Hence, most of the times they APPROVE what is being advised, until.........the shit hits the fan, which is

Hence, they will blame CIA, FBI or the Federal Reserve for BAD ADVISE.

It never changes.

Bear's picture

In January of this year the FED (illegally) created 236 Billion UDS to support certain foreign banks which have a US presence. In 2008, post Lehman the FED (illegally) created 9 trillion to add liquidity to US money markets ... The FED creates money and then asks for permission in times of 'crisis' 

ekm's picture

They were not illegal.

RebelDevil's picture

Congress? What's ya talkin about?

Seriously, dollars are printed at the treasury on behalf of the FED, (Federal Reserve Notes!?), but the money supply grows due to fractional reserve banking (ahem, the FED!!)

QE or not, the FED "prints" money. (Though only the treasury has power to actually produce currency you hold in your hand.)

TN Jed's picture

Quadrillion? I thought 660b was 2/3 trillion.

knukles's picture

1 trillion and higher now counts as "a shitload"

TN Jed's picture

Good point.  I think the largest printed bill is in fact the "shitload" note.  When people start mixing their trillions and billions, as I see all the time on tv, you know it just doesn't matter how many shitloads make up a shitton.

knukles's picture

Nobody really seems to give a rat's ass anymore, anyway.  They talk about 100's of millions thrown about on literally meaningless projects and plans just to appease 3 people in some run down part of East Wherever, talk in terms of trillions without any sense of reality...
They don't care anymore.
They're not serious about not spending taxpayer money like drunken sailors
It's plain that when liberals and neo-cons argue about whose fault it is about spending on this and that and cite each others horseshit small in the total picture of things expenditures, that they really don't care except for winning the argument.

Math be damned

Nobody cares anymore