BNP Warns "You Can Never Leave" From The Fed's "Hotel California"

Tyler Durden's picture

Via BNP's Paul Mortimer-Lee,

In the 1977 Eagles song, Hotel California, a luxury hotel appears inviting and offers a tired traveller comforting relief from his journey. It turns out to be something of a nightmare, however, and he finds that "you can check out anytime you like, but you can never leave".

Does that sound a little bit like QE and the Fed? The FOMC signalled its intention to check out of QE at its June meeting, but by September, it found it could not leave. The backup in yields that the announcement had sparked, together with worries about fiscal fisticuffs in Washington, was damaging an already not-very-vigorous recovery and hurting confidence. So, the Fed took a rain check. Is that not just like QE1 and QE2, the scheduled ends of which had to be reversed within relatively short periods?

The question now is whether or not we should expect repeated market obstacles to a QE3 exit.

Chart 1 shows that at the end of previous QE periods, stock-market volatility has, after a short time, risen considerably. This is part of the rationale behind the “open-ended QE” introduced in 2012. Instead of being date-dependent, Fed balance-sheet expansion became state-dependent: QE will be scaled down only when the economy is robust enough and the recovery sufficiently well entrenched that QE can be phased out without a derailment.

The effects of this most recent episode of QE compared with others have been different for the bond market and for equities. What we saw with QE1 and QE2 was that the start of QE was marked by a bond-market sell-off. This time, it was the flagging of the end of QE that prompted higher bond yields. In contrast, the end of QE1 and QE2 was marked by lower bond yields. When QE1 and QE2 ended, we saw a rise in VIX volatility. This time, it did not happen. The question is, how to explain these differences?

Let’s take the last one first. Previous episodes of QE saw higher equity-market volatility after a time. It may be that the VIX was affected by other events (such as the euro crisis) in the earlier episodes, or that the change in flows takes a while to feed through to the equity market. In May/June, QE3 did not end. There were extraneous events – the fiscal shenanigans in Washington, for example – but the market shrugged them off. Our assessment is that QE does matter to the equity market, but it takes time to work through. What appears to matter to equities is the actual size of the Fed balance sheet, as is clearly shown in Chart 2.

 

 

What about bonds? Why did the end of QE1 and QE2 result in lower bond yields, when bond yields rose this year on the suggestion of QE3 ‘tapering’? The answer is that bonds are a far simpler asset than equities and their pricing depends much more on expectations of future rates. Chart 3 shows 10-year bond yields and Fed funds futures 24-pos. It is clear that bond sell-offs and expectations of higher Fed funds go together (the simple correlation is about 70%). Also, in state-dependent QE, a decision to taper is a signal by the Fed that everything is okay – so prompting the markets to price in a return to normalcy quickly.

 

Exactly how bond yields and future Fed funds expectations move will depend on the circumstances surrounding changes in market expectations as to Fed policy, in its various dimensions. QE1 and QE2 were responses to concerns about deflation, as shown in Chart 4, while 10-year breakevens were at local lows before the announcement of each programme. QE was seen as potentially inflationary to a greater degree than it is now. QE was, therefore, associated with a rise in breakevens that was pronounced. Higher future inflation raised market estimates of future Fed funds and bonds sold off. When QE1 and QE2 ended, breakevens fell back. To a considerable extent, the first two episodes of QE were perceived by the market as a substitute for Fed funds action.

 

This has not been the case with QE3. Breakevens had been on an upward drift during Operation Twist. Q3 was not motivated by fears of deflation, as QE1 and QE2 had been, but by hopes of achieving “escape velocity” for the economy. Furthermore, previous experience had calmed market fears – and the fears of some on the FOMC – that QE would be inflationary. Signals that ‘tapering’ would come were associated with the market moving forward its estimates of the timing and extent of Fed funds hikes. Why the difference?

The answer is that the first two episodes of QE were date dependent and QE3 is state dependent. Tightening policy – what the end of QE1 and QE2 represented – was not seen as economically justified by the market, so bond yields fell when they finished. QE3’s state dependence makes it logical for the market to conclude that an economic state that would persuade the Fed to taper would also be likely to prompt it to hike earlier than previously thought. To the market, Fed funds and QE are now complements, not substitutes.

The other important factor that explains the sell-off in bonds over the late spring and summer is the increase in term premium sparked by the talk of ending QE3 (Chart 5).

So, now that we understand the past, we can ask whether we are ready to check out of hotel QE or not. We can break this down into a number of parts:

  • What will be the effect of tapering on Fed funds expectations in future?
  • What will be the effect on the term premium?
  • What will be the effect on equities once the Fed’s cash flows change?

The minutes of the Fed’s September meeting make it clear that the committee was disturbed by how much the market was pricing in higher Fed funds. It discussed various ways of delinking the decision to taper from the decision to move the Fed funds rate, including clarifying its guidance to state that the committee would not raise its Fed funds target if inflation were seen running below a given level, or providing more information about its intentions after the 6½% threshold for unemployment was crossed.

Other options could include, we would suggest, reverting the Fed funds to date dependency (unlikely, considering the relatively recent switch from date to state dependency) and giving a clearer forecast path for the Fed funds rate (à la Riksbank). It would be useful, we think, if the Fed were to give some metric to guide the market about how the economy’s evolution would affect the pace of tapering and its duration. We know what the threshold is for rates, 6½%, but what is it for tapering? 200k payrolls? If tapering starts and then payrolls fall back to, say, 140-150K, will tapering cease or slow down?

Some action to try to separate Fed funds and tapering expectations (if not these specific measures) seems likely, though the timing is uncertain. Will it succeed? The efficacy seems doubtful. Expected Fed funds will increase when the Fed announces tapering, because the market will conclude it has changed its assessment of the robustness of the recovery. The only question is, how much? There is some evidence from the eurozone that is pertinent here.

Remember the rate hike in July 2011? The ECB at that stage was appealing to the “separation principle”. It contended that it could use interest rates to control the economy and inflation risks, while less conventional policies could be used to control the crisis. It quickly learned that the separation principle was one thing and separation practice was something entirely different. The market saw them as two aspects of the same thing. It will probably be like that for the Fed also, no matter how fervently the FOMC wants to separate Fed funds action from QE tapering.

The term premium seems less likely to spike when actual ‘tapering’ is announced than in May/June, simply because it has not gone back to previous levels, though it has declined a bit. Another way of looking at this is that the Treasury 5y5y sold off very aggressively during the ‘taper tantrum’ and has only rallied part of the way back. Based on where future nominal GDP growth and the Fed funds rate are likely to settle, this does not seem as overly optimistic as it did early in the year.

Closely tied in to the discussion of how far the term premium can rise is whether QE’s effect is due to the stock of QE outstanding or the flow?

The Fed has historically been in the stock camp, as this ties in with the portfolio-balance model it has used to calibrate QE. Markets generally put more emphasis on the flow, as prices are determined at the margin. Even if the stock matters, we can rationalise an apparent important flow impact by saying that a change in the flow alters the long-run expected stock of assets the central bank will hold.

One other reason that central banks may be inclined to believe that it is the stock that matters is the Hotel California syndrome. If it’s the flow that matters, stopping purchases may be tough, especially when the flow is large. Like a smoker needs another cigarette to feel normal, the economy may need continued purchases to feel ‘normal’. If, in contrast, it’s the stock that matters, then stopping purchases leaves a very large stock of easing still out there and the impact on markets of tapering should be much smaller.

What does the evidence suggest? May/June indicates that there is a significant flow effect. Certainly, the sell-off in bonds and the associated rise in mortgage rates were much larger than the Fed expected and they had a notable impact, on mortgage applications, for example. However, we could rationalise some of the effect on the back of the Fed statement pointing to a big change in the future terminal stock of purchases in circumstances where the market did not view data as sufficiently strong to trigger tapering.

Perhaps more instructive is the end of previous date-dependent periods of Fed QE. The end date was known in advance, so the expected shift in stock should have been small. If this was a pure stock effect, there should have been no impact on markets. As we saw in the charts above, this was not the case. This is very decent evidence of a flow effect.

In terms of QE’s impact on markets, a variety of studies (by the Bank for International Settlements and the Bank of England, among others) put the impact on bond yields of QE at 100bp or more (the BIS calculated that in the absence of altered Treasury issuance, US yields could have been 180bp higher than they were and that the net Fed/Treasury effect was of the order of 120bp). However, these tend not to isolate the term-premium effect from the Fed funds expectations effect. Nonetheless, it is interesting to note that the impact of ‘tapering’ talk was broadly of the same order of magnitude.

With markets having rallied since the FOMC baulked at ‘tapering’ in September, we should still expect some impact from the announcement of future QE ‘tapering’ on the term premium and some further effect as ‘tapering’ proceeds. How much will depend on the economy, as the Fed has said it is data dependent. Overall, we should not expect the same degree of sell-off in bonds as with the false start to ‘tapering’ this year. But it seems likely that we will breach the 3% barrier (the previous high) within a few months of the announcement of the start of ‘tapering’.

When it comes to equities, announcement effects seem less important than for bonds, and flows seem to matter more. Moreover, with state-dependent QE, the signals are more mixed than for bonds. Equities will have to cope with higher bond yields, but these will only come if the Fed thinks the economy is sufficiently robust to withstand them. Moreover, if QE adversely affects the term premium on bonds, investors may choose to switch from bonds to equities. It is possible to argue for a more favourable reaction of equities after the end of state-dependent QE than date-dependent QE.

We should, on the basis of past evidence, expect stocks to suffer with a lag and maybe to see a fuller reaction once QE stops altogether. At that stage, and depending on the impact on the economy, we could see the adverse impact on bonds diminish or reverse.

Our overall assessment is that when the Fed decides to ‘taper’, there will be an adverse effect on markets. Bonds will suffer from a higher term premium and an upward revision of expectations about future levels of Fed funds. Equities are likely to suffer, too. How big the selloffs will be will depend on the circumstances – how robust the recovery looks, to what extent inflation remains quiescent and to what extent the current period of maintained QE leads to excess valuations in markets. Those markets that sold off most during the ‘taper tantrum’ tended to be those markets that had rallied most in previous months.

Clearly, this is one of the disadvantages of QE – one of its purposes is to distort markets. When QE ends, those distortions begin to unwind. Because of the disequilibria in financial markets under QE, relative valuations, as well as valuations of the risk-free asset, are distorted. Markets may go through considerable gyrations as they try to find the “right” constellation of equilibrium prices. It is possible that sufficiently vigorous reactions could adversely affect the economy. Chart 6 suggests that when bond yields rise by more than 25% of their previous level, it tends to represent a challenge to economic growth.

It may be difficult to foresee all the effects of ending QE. After all, except with relatively brief breaks, the Fed has been using its balance sheet to stimulate the economy since 2009. Markets and the economy have gotten used to it. Will there be unexpected effects when QE ends? Seems like a good bet. What they will be is more difficult to say.

What does all this mean for Fed ‘tapering’? On the one hand, it can be argued that the ‘taper tantrum’ in the earlier part of the year should make the Fed more cautious about beginning to wind down QE now. The counter-argument is that as the level of yields has moved up a good deal, the benefits of QE are now less than before, so that hurdle has been lowered because the benefits of continuing QE have diminished. Both are probably too tactical in outlook.

The Fed will make the choice on strategic grounds, namely, whether the recovery is sufficiently robust to warrant a slower pace of purchases. The prospect of fiscal disagreements early next year and uncertainties about the data and distortions to them currently make it difficult to be sure when tapering will start. Our best estimate is March, with roughly a one-third probability that it will come later.

Once tapering does start, the indications are that the Fed would like to complete it within a year. However, if it is data dependent, this is far from certain. In the event of adverse reactions from markets that impact the real economy, the Fed may have to slow its exit, or even pause it. We do not buy into the full Hotel California story, but we can see that leaving, as with QE1 and QE2, might be a bit more difficult than the Fed expects. Why? Because flows matter.

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FieldingMellish's picture

"QE is a nothing event." - Eugene Fama, Nobel prize winner in the dismal science.

Abi Normal's picture

It's really a roach motel, you can checkin but never check out, hehehhehe!  This is a nightmare to watch unfolding, one seam at a time, watching grass grow, lawn bowling...did I say lawn bowling?

It's worse than I thought, I have officially lost my bearings, which way is south?

DoChenRollingBearing's picture

.

"...I have officially lost my bearings..."

 

Hey!  Stop that!  (see below)  :)

Carpenter1's picture

Good read, except the part where he states, "when the FED starts to taper."

News flash, the FED will NEVER taper. This will not be different, we will circle the drain in ever smaller rotations, all the while printing moar and moar fiat into oblivion, where we are going.

spine001's picture

Flows not only matter, they are the ONLY thing that matters, for as long as you keep flows going, nobody really understands how much of the money they have, is real and how much is inflated paper. Touch those flows, so that they affect the Senator or banker that wants to buy something in such a way, that he can't buy now due to disequilibrium in flows and the Pandora box opens, and all hell breaks loose.
The world payment settlement system is based on flows, nobody really cares about principal, only as it affects flows, if you have any doubts about this check what happened in Cyprus.
If you want to understand when will all hell break loose, you need to understand flows and track them. When they get unbalanced, the system explodes in minutes, not hours, not days, just minutes, perhaps even seconds.
What the FOMC doesn't understand is that as they make total capital = total debt larger, its impact on flows increases exponentially, making very small variations in interest rate have larger and larger impacts on flows, making their equilibrium a harder and harder task, thus increasing the instability of the whole financial system, there is no scape to this, just bring it to the limit, as all engineers and mathematicians do to understand a complex funcion like sinus (x)/x and see what happens when capital is approaching infinity (200 trillion in net present value of all future balance of payments sounds to me like approaching infinity for most practical purposes) and see what a 1% change in rates does to flows. 2 trillion for each 100 basic points, 200 billion for 10 basic points and 20 billion per basis point of change. Funny isn't it.

DoChenRollingBearing's picture

Actually you CAN leave the "Hotel California"!  One option is Peru.  We leave tonight back to the USSA (and our first trial as "Trusted Travelers" (LOL), that new card they give you after paying $100, an interview and background check that allows you to jump the line at arrival Immigration into US airports).

But, I received a lot of nice words for my Peru pieces, so here are more pictures and comments.  I include a lot of oddball vehicles (for the USA) because many of my inyternational readers like these.

"More Peru Photos: Olloquito, Mountains, Vehicles, Bearings"

http://tinyurl.com/mqbcs4t

PacOps's picture

Ah but not withn the CA Franchise Tax Board. If you ever breathed the air here then you are on the tax roles and moving somewhere else does not get you off of them. And yes, they will levy and seize no matter where you live.

DoChenRollingBearing's picture

 

 

Thank you for letting me know.  

I hereby officially declare that Mr. and Mrs. Bearing will not move to California.

playnstocks's picture

Dead ON!  I hate getting letters from them ... Never good news!

duo's picture

I've been to the "Hotel California" down a dark desert highway in Todos Santos, BCS, Mexico.  The Eagles did a lot of drugs there in the 70's.  It was boarded up when I was there 10 years ago, so you could leave, but you couldn't check in.

blindman's picture

it is a "nothing out of the ordinary" stealing, fraud,
rape and murder event, he is correct in that.

Carpenter1's picture

I've come to believe people like him are not as moronic as their incredibly stupid comments would suggest.

No, they are terrified. This system is their domain where they earn a good living and are respected. They see it teetering and gathering around the edifice to prop it up, or try.

In the end, some will recant hoping to save their own skin, but most will go down with the ship all the while desperately trying to bail water. I expect to hear more nonsense from them, bordering on, and then crossing the border into insanity. That will be the end, when even the average sheep can't bring himself to accept the lunacy coming from the mouths of our so-called, self-appointed leaders.

Hail to the noose! Get lots, we'll soon have some hangin to do!!

Notarocketscientist's picture

Fama can top off his Nobel with a Dunce Cap

Kirk2NCC1701's picture

1.  It's not just the Cream that rises to the Top.  Turds float too.

2. Shit flows downhill.

Plan and act accordingly.

Abi Normal's picture

Not all turds float Kirk...but shit does roll downhill alright!  Am planning accordingly myself!  This turdbowl is about to blow, huge black clouds in the near future friends.

TheFourthStooge-ing's picture

Mount Crapatoa is rumbling ominously.

Debeachesand Jerseyshores's picture

Just end the QE Shit and let the chips fall period.

Pasadena Phil's picture

Whatever happens, we can deal with it.  We will have to sooner or later and it will only get worse the longer we wait. Nothing is getting fixed and bad habits are setting in to stay.

NOTaREALmerican's picture

Re:  Whatever happens, we can deal with it.

The problem is "whatever happens" is going to badly affect the top 10%.    They aren't going to be able to deal with it too well.  In fact, they are going to be really pissed when "whatever happens" happens.  

I really think they've suffered enough, personally.  It's tough having all the responsibility.

Pasadena Phil's picture

"Whatever happens" will happen regardless of what we think or do. We either deal with it at our time of choice or we wait for reality to invade our little world of blissful ignorance when we are least ready. You can't outrun the math forever. Take the pain. cut your losses  and move on.

Watson's picture

>>>
We will have to sooner or later...only get worse the longer we wait.
<<<

Entirely correct.

But it is rare indeed to have a politician voluntarily propose 'pain now', however good the long-term prospects as a result.

So since even a discussion of QE-exit caused wobbles, QE is here to stay, probably ever increasing until an external event (to the US) collapses the debt house of cards.

FWIW, my personal theory as to the external event: China, having completed it's overhaul of the Chinese gov bond futures market, and established CNY swap lines with every major central bank, announces that with immediate effect all restrictions on the holding and transfer of both CNY and Chinese govvies have been removed.

Such an announcement would destroy UST's...

China loses money on it's UST's (but not a democracy, so who cares).
But CNY becomes the new reserve currency. Better than gold, actually, because gold is just restricted in supply, as China runs surpluses, free float CNY always going down.
Pax Americana moves to the East...didn't Napoleon say something about 'sleeping dragons'?

Carpenter1's picture

Well said. I would only add this. When CNY achieves reserve status the world will have need for many trillions of them immediately. Do you think maybe China could buy themselves a world class, USA defeating military with 100tn CNY at its increased and increasing exchange rate?

Revelation: I saw their number, it was 200 million.

And all sporting dazzling armour. Assume the air, ocean, and land hardware aren't far from this army.

Pasadena Phil's picture

I doubt it but once war starts, anything can happen. China would have to take the war to us were we to decide to redefine our military mission to defend only our own national interests. Regardless of their enormous population, they can't project that advantage overseas which they would have to do to take us 0on. They still have their nuclear weapons but that is probably a last ditch option for them because they don't do well in that scenario either. Our military is the best equipped. most experienced and most modern and backed by the best global support network.

The thing about China is that they aren't really a united country. How many versions of Chinese they speak? Ninety? And most of them can't read. They've been doing better feeding themselves but they could not take us on by themselves and their most likely allies can't feed themselves. And they don't have the energy souces that we have. We don't even need Canada and Mexico anymore if chose to tighten our belts.

And then there is industrial capacity. China is still not in our league when it comes to high-tech sophisticated manufacturing. And we can ramp that up in a flash. Thenn add the fact that we are still very innovative whereas they have to steal technology, it would be a matter of surviving the intitial phase of a war and then wearing them out with out abundant advantages. They would have to invade the entire North American continent. We wouldnt be looking to occupy them.

I just don't see losing a war to China. And Russia is not a very serious military anymore. Their military is more like a gang of thugs. Look at how they handled their invasion of Georgia. They are just thugs not professional soldiers. They might be willing to take huge body counts to win battles for a while but you can't win wars that way. And they sank their most modern submarine in shallow water on launch because they left a torpedo tube open. They are a joke. A Russian-speaking McHale's navy.

Pasadena Phil's picture

I have no fear of China. They are a house of cards just waiting for a little breeze to trigger their collapse. The Fed owns more treasuries than China and the Treasury could decide to do a little consolidation accounting within the government and retire what I understand is about $2.1 trillion of debt by itself.

We could also decide to squeeze China by threatening a selective default. They might then seize American assets in China and we're off to the races. In the end, they have much more to lose than we do and could not afford a war against the only nation on earth that can operate very well all by itself. We have the only real military left, we are the only country that can feed itself and the only country with abundant energy. Those are a lot of cards to hold and the world knows it.

It may seem that we have no friends in the world but the realpolitik of survival would nudge most of the important ones whose national interests aren't worth squat without us to quickly make it clear that they ARE our allies. And the longer it takes for them to say it, the more likely we will be forced them to make them prove it.

It's good being us. We just need to start thinking like a nation again and drop the globalism We are NOT the world's police and the world is not a national interest. We can afford to be us, the nation. We can't affort to be everybody, the world. Good fences make good neighbors.

DoChenRollingBearing's picture

IMHO, correct!  We (USA) will not fall because big bad China defeats us.  We will only fall if we defeat ourselves.  

The USA, with all of its problems, is still the best place where I would want to live.

My opinion is subject to quick and sudden change however...

Watson's picture

America does indeed hold a lot of cards. There would be no real problem if Americans could somehow wean themselves from chronic over-spending (both entitlements and a grossly excessive military), which is funded through externally held debt.

_threatening a selective default_
FWIW I think this will actually happen, simply because the US overspending is now an addiction, and will never stop until a hard reset is forced.
The Chinese won't be very happy, of course, but war? I think not. Firstly (as stated above) they aren't a democracy, they don't have to explain to voters how they've lost so much in UST's. More importantly, they will calculate that the repercussions of such a US default will improve China's position in the world.

The 'hard reset' for the US is not _necessarily_ bad.
It could start a move to the sort of prudent, live within your (substantial) means type of society envisioned by the founding fathers, probably (as you say) withdrawing a bit from the world. The debt addiction is a post WW2 phenomenon, a comparatively recent thing.
Obviously, another possibility is a complete breakdown of society, particularly in the cities - and US citizens seem to have a lot of guns.

Mad Max or Amish-like Utopia...

Pasadena Phil's picture

The way I see it, the main adjustment we have to make as Americans is to face the reality that there is pain heading our way and we can't avoid it. But if know why and make the grown-up decision to face the consequences, we can then find solace in being a untied country again which will make that tunnel of pain bearable because of the hope anc confidence that it won't be forever. That is better than the hopelessnes so many of us now feel watching our corrupt establishment making things worse and worse by the day.

Solarman's picture

Well said.  I make the same point all the time.  A more interesting alignment is if Russia and Germany try to hook up again.

NOTaREALmerican's picture

When flow matters, go with flomax.  

kill switch's picture

QE Will not end..........soon to be 170 billion a month,,,what is all this nonsense about tapppppering????????????????????????? NOT GOING TO HAPPEN,,, STACK FUCKING GOLD!!!!!!!!!!!!!!!!!!!! All the Chinese are doing it!!!

CrashisOptimistic's picture

As discussed recently, QE is not some whimsical act by a handful of Fed Governors who are entirely amoral.  Every one of those people take action to try to accomplish their dual mandate of maximizing employment (which is NOT the same as minimizing unemployment) and limiting inflation (with Bernanke making clear the limit is from both directions . . . 2%, neither too high nor too low).

The real focus of ZH should be the question of how, with all the printing that has taken place, did not dilution of the dollar explode.  No, don't lean on the money tied up at banks.  It is, but not for any conspiratorial reason.

Rather, because the money is disappearing.  Mortgages continue to default in enormous amounts.  The elimination of mark-to-market conceals this on the bank balance sheets, but it is ongoing, and QE is an ongoing bailout of the financial system that would implode from the eradication of these trillions.  If banks had to report this, your ATMs would stop working and riots would start.  So the Fed replaces the money disappearing.

The fundamental question is why are the mortgages still defaulting?  The answer: relentless, inexorable, crushing, continual economic  decline.  Every day another loan holder defaults his mortgage or car loan or student loan.  People can't pay these loans.  The loan is in default.  Money disappears.

Ben replaces it.  Forever.

Oh and btw, before you dismiss this because data says there are fewer mortgages delinquent etc, look closely at that data.  Banks change the terms of the loans, reduce the interest rate some or payments req'd, they inform the mortgage holder of this offer, the mortgage holder accepts the offer and that allows the bank to remove that mortgage from "delinquent" category.  The mortgage holder didn't get a job.  He didn't catch up on payments.  But they improved that statistic.  It's bullshit.  The defaults are ongoing.

Carpenter1's picture

Begs the question: what's to be expected from replacing mostly M2 with M1, if anything?

CrashisOptimistic's picture

It avoids deflationary implosion.  Bernanke is laser focused on that more than anything else.  It is THAT which compelled the whole "2% from either direction" goal. 

He will print forever if that's what keeps blood out of the streets.

What folks who decry it miss is the why question.  Why does he do it?  To replace disappearing money.

The real why question is underneath that one -- why is it still disappearing?  That answer is in the eroding joules ratio, but that is so intellectually disconnected a concept that it can't be embraced by most.  The fact that it is eventually lethal also prevents acceptance.

Solarman's picture

Crash, my question to you is what happens when velocity continues to shrink towards 1?  Helicopter time?

RaceToTheBottom's picture

If that was so then why would not the FED just buy up all bad loans?  Remove WS banks from equation.

Solarman's picture

Because that ends the illusion, and many preferred elite bond holders are then cooked.

Solarman's picture

You are correct.  You can see it in the total credit numbers, and in the banks net interest numbers.  I have a trading blog and today I posted peak QE.  All  three  mandates have peaked. Employment, inflation, and the market are now falling.  Now the slope of balance sheet growth must increase not just rise to gain more of what they want.

Pareto's picture

It really is that simple isn't it.  +1 for clarity kill switch.

Being Free's picture

They stab it with their steely knives,  But they just can't kill the beast.

ShrNfr's picture

So I called up the Bernake,
"Please bring me my unwind"
He said, "We haven't had that spirit here since 2 thousand and nine"
And still those voices are calling from far away,
fire up the printing presses we will print more today.

NIHILIST CIPHER's picture

Hotel California/Federal Reserve both run by same guy Satan/ ChairSatan.

debtor of last resort's picture

Taper is like the lion pulling back it's teeth from the deers throat when it doesn't move anymore. So let's wait for the lion in the headlights.

Abi Normal's picture

Taper schmaper!~

Not gonna happen, the trial run failed, plan ABC to infinity and beyond!  Junkies need their junk, man!  Wall St is delerious with easy money, banksters are fat and happy, what happens when the other shoe drops?  Muni bankruptcy en masse? Upcoming cuts in foodstamps?  EPPI UE, etc?  Ever thought of the hucksters (FSA) that depend on that free money?  Wonder what happens when the spiggots are turn off entirely?  Never going to happen you say?

I can give you too many reasons why it can and will happen, soon.  Problem is, most ZH's know this already, so preachin' to the choir, eh?

Fucking sad state of affairs! 

blindman's picture

http://vimeo.com/32659326
Hotel California - The Eagles (MTV Unplugged, 1994)
.
speaking of dark Halloween themes and scary stuff!
it takes a village to support your self destructive habit
or your lofty financial status. check it out but you
can never leave.
what is so "happy" about Halloween? the saying should go
"have a funny halloween" or something like that.

Seal's picture
If you kill off the prairie dogs there will be no one to cry for rain.

- Navajo warning

Read more: http://www.sulisminerva.org/2009/04/prairie-dogs-cry-for-rain.html#ixzz2jLLmWuta 
Under Creative Commons License: Attribution

Alexandre Stavisky's picture

Beautiful.  Love that idea.  All beings under heaven having access to the great architect.

...Once having undertaken bond fraud and unsterilized monetization, suppression of interest rates, and ZIRP...

WHAT IS TO STOP THEM FROM AN IMMEDIATE PRINT TO INFINITY?  NOTHING.  ONLY THE WISH TO EXTENUATE OVER TIME TO OBTAIN THE MOST BENEFIT FOR THE LEAST DESERVING BY DILUTION FROM LABOUR/CAPITAL POOL.

Money Printing, Energy, Sovereign Bond Fraud...Warfare.  The last great bubble. Perversely I foresee a crackup economy very robust (aka Germany 1920's) before some massive dislocation of revolution, poverty, or hard reorganization.

Bottom layer of the pyramid cake will have hard, hard, hard times, indeed.  Indeed, indeed.

Pareto's picture

No disrespect, but, I needed bread crumbs to find my way back to what the original thesis of the article was/is.  Taper is a distraction, in my opinion, and it aint NEVER going to happen.  The sooner the media stops placating to all this bullshit taper talk (Thomas Keene has to be the worst - demonstrating a complete lack of understanding of the economic problem), the sooner the curtain will be pulled and the market left to learn to stand on its own.  The longer we play pretend, the worse reality will be, in my opinion.

blindman's picture

the media will do as they are scripted to do and
no more.
.
31 OCTOBER 2013

SP 500 and NDX Futures Daily Charts - The One Percent's Lament: Poor Poor Pitiful Me
"The press is the hired agent of a monied system, and set up for no other purpose than to tell lies where their interests are involved."

Henry Adams

"For the game had never been fair, the dice were loaded. They were swindlers and thieves of pennies and dimes, and they had been trapped and put out of the way by the swindlers and thieves of millions of dollars."

Upton Sinclair
.
http://jessescrossroadscafe.blogspot.com/2013/10/sp-500-and-ndx-futures-...

spine001's picture

Dear Paul Mortimer-Lee, your own graphs answer your question in much simpler terms than your article does:

"This time, it was the flagging of the end of QE that prompted higher bond yields. In contrast, the end of QE1 and QE2 was marked by lower bond yields. When QE1 and QE2 ended, we saw a rise in VIX volatility. This time, it did not happen. The question is, how to explain these differences?"

When the Fed's balance sheet size change has a positive slope the markets go up, when the slope is zero or negative the markets crash, it is true in your graph, and may be in all of history, need to get the data to check it out, anybody can provide a link to the data? I'll do the analysis. During the announcement of tapering the slope remained the same, as positive as before, thus NO change in the stock market.
On the other side, the effect on the value of bonds, comes from the percentage of the overall market that the FOMC operations are covering, as they become larger and larger, the operators accommodate by finding other more profitable investments, as soon as the big buyer announces he is going to stop buying as much, prices go down, simple microeconomics 101. The smaller the buyer is and the shorter the period this buyer has been buying, the less impact it has that he decreases or stops his buying, since the market didn't accomodate supply / demand curves. The longer the FOMC maintains QE3 the tougher it will be to remove it, since the demand for bonds would have completely stabilized at a lower value, the only way to change that would be to get some strategic agreement with Japan, China or the EU to replace the FOMC and have them taper slowly and unknowingly to the other buyers. But somebody will loose big time. If you are in doubt ask the London Whale :) LOL.