"We Will Soon Learn How Strong The QE Trap Has Become"

Tyler Durden's picture

Submitted by Derrick Wulf via NoEasyTrade blog,

Reading between the lines of recent Fed communications, it’s becoming increasingly clear to me that the Fed wants to exit its quantitative easing policies as soon as possible. Though they’re loath to admit it, the architects of quantitative easing now recognize that their efforts are achieving diminishing marginal returns while at the same time building up massive imbalances, distortions, and speculative excesses in the capital markets. Moreover, they’re realizing that the eventual exit costs are also likely much higher than they had previously thought, and continue to rise with each new asset purchase. Never was this more clear than when the Fed first hinted at tapering its large scale asset purchases over the summer: equity prices fell, interest rates rose, volatility increased, and huge sums of hot money were repatriated from various emerging markets, causing significant disruptions to local overseas economies and currencies in the process.

The market’s strong reaction to the mere hint of a taper also threw cold water on the widely held belief among Fed officials that the primary impact of their asset purchases comes through the accumulated “stock” of their holdings rather than the ongoing “flow” of purchases. This sudden and unexpected realization among policymakers has forced a complete rethink of their strategy. Indeed, one of the most basic premises of their monetary policy assumptions has been shown to be false. Markets are, in fact, forward looking.

Fearing the economic impact of an unwanted tightening of financial conditions, the Fed quickly stepped back from the tapering abyss in September. Since then, FOMC officials, along with their staff researchers and economists, have been working diligently on devising a new strategy, floating numerous trial balloons along the way. Their primary objective is to allow for a taper and ultimate exit from QE while somehow minimizing the flow impacts of such a shift in policy. There has been a renewed focus on the Fed’s other policy tools – namely the overnight lending rates and forward guidance – as a means to that end. There have been active discussions about lowering unemployment thresholds, increasing inflation tolerances through “optimal control,” and cutting interest on excess reserves to help guide market expectations towards a lower future path of interest rates.

It is my belief that one or more of these options is likely to be adopted alongside a modest tapering of asset purchases, perhaps even as early as December. While central bank officials don’t want to disrupt the fragile economic recovery through a premature tightening of monetary policy, they are also well aware that the longer they wait, the more difficult it will become later on. In a word, they’re starting to feel trapped. They want to wriggle themselves free of this as soon as conditions will possibly allow.

I expect to see more public comments and newspaper articles indicating as much in the coming days and weeks. Economic data – namely the November employment report – will clearly play a very important role in shaping expectations as well, but barring a material deterioration in the employment and growth outlook, I expect a tapering announcement, coupled perhaps with an IOER cut or more aggressive forward guidance, to come sooner rather than later.

Implications for the markets, which may not yet be fully prepared for this outcome, are likely to be significant. In short, I would expect yield curves to steepen, the dollar to strengthen, equities to fall, credit spreads to widen, commodities to weaken (the metals in particular), and volatility to rise. How the Fed will then respond to these developments will be very telling indeed. Their hand will be forced, and we may all soon learn how strong the QE trap has become.

My preferred strategy until then is to buy inexpensive volatility, either directly or indirectly through longer-dated options, and to continue to trade the Euro and Yen from the short side.

I also like maintaining a core curve steepener, preferably in 5s / 30s (or long FVZ against a duration-neutral USZ short), and establishing some equity shorts near trend resistance around 1810 in ESZ (see yesterday’s note for charts). On the curve, with 5s / 30s now having cleared resistance at 240, I expect to see 300 tested again before much longer, with new wides to follow.



The first two major episodes of the current multi-year steepening trend – the crisis and the response – both widened the 5s / 30s curve by 200 basis points. If the third episode, the exit, follows a similar trajectory, we could see eventually see 5s / 30s hit 390.



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TrustWho's picture

PhD, the great, great majority, are COWARDS. Bernanke and company blinked in September. Yellen has no balls. The Fed will do everything in their power to keep from being perceived as the match that broke the camels back. They want to position themselves as the institution that did everthing possible, so the collapse is someone elses fault.

Volcker was a PhD with courage.

zaphod's picture

The FED will not blink until the market forces it to.

In the late 70's / early 80's the market finally forced the FED to blink. This is why Volcker was brought in.

Until the market takes rates to +10% on its own and foriegners genuinly threaten to abandon the dollar, there is nothing forcing the FED to stop

NotApplicable's picture

Friday humor, Tyler? The idea that the Fed is desperate to exit, since they're finally aware that QE isn't working, is quite the joke.

Author sounds young. Very young.

CheapBastard's picture

Pension Funds are already massively underwater, esp the municipal funds. Any cut to QE would cause even more serious problems. You'll see hundreds of detroits and san bernadinos.

Sorry. There'll be no QE in myt lifetime. If anything, they'll need to double down.

AldousHuxley's picture

Ask Japan how long they have been doing QE....

King_of_simpletons's picture

It is time to increase the QE, not taper it. We have come this far. Let's ensure the work gets done.

Now is not the time to relent on a couple of trillion dollars.

AurorusBorealus's picture

What will likely happen is that they will taper their purchases from MBS in favor of municipal bonds.  They may begin by decreasing their MBS purchases slightly more than their Municipal bond purchases... this is the closest thing to a taper that we are likely to see.  As pointed out by another commenter above, a small increase in interest rates is disastrous.  They cannot taper; they will not taper; and any attempt to do so will be very short-lived.

andrewp111's picture

Volker did not face a true Game Over situation from his tightening. There was a recession and a strong recovery. This time the Fed is really trapped. They know that when the global Central Bank Bubble ends, the whole financial system as we know it today comes to a very sudden end. They know that with a divided legislature and a totally incompetent socialist as President, there will be no help from their political masters. They know they have to keep the bubble going until it blows, just like the bomb-rigged bus on Speed.

uncle.bigs's picture

1.  Gold/silver have been crushed throughout the massive QE so I doubt pulling back modestly is going to impact much.  In fact increasing volatility in other assets may cause a safe haven bid to the metals.


2.  Pulling back QE is unlikely to cause the yield curve to steepen because it would conceivably lead to slower economic growth.  If anything the yield curve would flatten.


3.  I doubt pulling back QE a modest $5 to $10 billion per month does anything material to the burgeoning stock market bubble.  It may cause a 5% pullback in anticipation and then rally hard on the news.    Historically the market does very well as the fed tightens.  The stock market climbed all the into the teeth of the fed's rate hikes throughout 2006-8.  

fonzannoon's picture

there is no historical precedent to compare with the fed unwinding this balance sheet. Hence any article that assumes it will be tried is a waste of time.

NoDebt's picture

Yeah.  Talk of unwind is more than a little premature when you consider they are still in process of winding it up as fast as they ever have.


SeattleBruce's picture

Which is why they won't do it until they literally falling off the cliff. And it won't be them unwinding, but the market (reality) - finally.

dracos_ghost's picture

But they will Taper QE. And then create a new asset program JFBSBWHNC (Just fucking buy shit because we have no clue) and say that is open ended.

If you like your Federal Reserve asset goosing program, you can keep it. Wait, that's another story ...

bunzbunzbunz's picture

Diversify before it's too late. Foreign currency, stocks, bonds, cash, gold, and don't waste your money on bitcoins - just get some free: http://freebitco.in/?r=25727

Robot Traders Mom's picture



For those of you that have asked about my son, he's doing well. Thank you for asking. He just got his real estate license last week. 

Running On Bingo Fuel's picture

Oh good. Thanks for the update.

I think Robo was the only one here that made money from 666 up to 1800 he just kept buying. And everyone was like, 'you dummy, don't buy stocks!".

It's a bear market rally.... It's going to crash. 3 years later, It's going to, I just feel it.... lol


NoDebt's picture

Not the only one.  Plenty here have whipped this rented mule for all it's worth.


Running On Bingo Fuel's picture

You say that now. But when Robo was highlighting trades during the ramp up, if you had agreed you would have been the laughing stock for the ankle biters.

I didn't hear you then bro.


NoDebt's picture

And you never will, bro.  I have no intention of opening what I do to public scrutiny for exactly those reasons.

And I wasn't on ZH back then anyway.


ceilidh_trail's picture

Gotta say, Robo did better with his momo's than I did with gold over the last two years. Haven't seen him on here for a year- either got the boot or run over by his own dirt bike?

infinity8's picture

LOL - did you take the test for him?

MrPoopypants's picture

I'm with Schiff and Jim Willie. They cannot taper, they can only pretend to with empty talk. The markets will wise up sooner or later. Fed has zero credibility.


quasimodo's picture

"The markets will wise up sooner or later."


Yeah, you would think so. Some of us here will probably be cursing and saying the same damn thing in 50 years, pecking on a keyboard with a drool rag in our lap after our sponge bath. 

NoDebt's picture

Looking at a chart of the S&P this year, I think it's safe to say the markets have already started to come around to the idea it's never going to end.

fonzannoon's picture

I like looking at that chart and trying to figure out what people mean by "diminishing returns"



new game's picture

he is making way too much sense; i can hardly take it anymore.

insanity by definition...

SeattleBruce's picture

Definitely diminishing, probably negative returns to the real economy from additional debt creation/enablement.

q99x2's picture

Yes the correlation between higher rates and conterfeiting is now verifiable.

Hope they can pull it off until the weather gets warmer. 

tempo's picture

QE is zero sum game. With QE interest rates decline, home buyers win but savers lose. When home prices increase buyers increase spending but savers have less money to spend. Maybe initially there is some positive impact. Now when QE stops interest rates will increase and home prices drop 20%+. we will be back to 2008 again, maybe worse. QE only pull forward economic activity but when it stops the economic hardship will be amplified because equities and bond prices will now drop 20%+. Obviously the FED and wall street know exactly what will happen is QE stops and interest rate go back to the level before QE, about 4%. The FED may want to stop but disclosing the lies is unacceptable. So QE probably will continue until there is an external event where the .001% and powerful can transfer blame for the cost of this policy.

NoDebt's picture

"QE will only pull forward economic activity"

And by the looks of things, there wasn't that much to pull forward to begin with.

new game's picture

not to mention the transfer of vast sums to the markets. so these vast sums are in play.

like nas 5k, where does that money end up? the sellers will be the winners.

in vegas they call it the house. on the street they call it the insiders.

whooooosh, before ya know it market is lock limit down, trades on hold only to fill

at dramatically lower prices; total helplessness and jump out the window feeling.

dispair is a coming...

buzzsaw99's picture

the fed already tried to taper three different times. the fourth effort will be no different. zirp 4 evah, qe infinity.

BadDog's picture

This week China fired off a flare to the rest of the world that it no longer would be accumulating foreign reserves. This is the signal for other countries with U.S. dollar reserves to dump them if they don't want to take the loses. So, who is going to buy the debt at low rates if not the Fed? No one.

yogibear's picture

China, Russia and others know the best way to defeat the US is economically.

The US Federal Reserve is already helping to destroy the dollar. The key kicking out one of the Fed's legs is to take away the petrodollar. 

Snoopy the Economist's picture

Who is going to buy the debt at low rates if not the Fed?

They will end up forcing pensions and 401Ks to buy them.

Ned Zeppelin's picture

This guy must work for the Fed. The first 2 sentences are filled with lies. I stopped reading.

Put simply, the Fed will stop QE when it serves its owners.

OK i lied. I kept reading. This article is written by a Fed Reserve owned personage. Perhaps it is humor.

Scritchy's picture

I couldn't read it either, Ned. Anyone (Yellen) who would want to follow Ben has to be an idiot or a shill, and will do GE to infinity and beyond either way.

NoDebt's picture

Politicians who win are the ones who promise more free shit.

Those who win Fed Chainmanship are the ones who promise more free money.

PT's picture

I don't like to disagree with you on this point but politicians routinely promise the moon and change their mind instantly when they get voted in.  So what is the real reason for them deciding to deliver?

NoDebt's picture

They don't deliver.  Just the promise is made.  If pressed, they say "if only you give me MORE power, I would be able to fully deliver on that promise".  

PT's picture

No.  They actually did deliver lots to the Free Shit Army.  Why?  Some of it is obvious.  eg the FSA fails to figure out that "more debt" and "affordable" are not the same thing.  But what about everything else?

ToNYC's picture

QEx is serf-cheese. If you are un-lucky, you get it? Save your buttons.

SDRII's picture

which is why the fed is out talking about other measures to thwart the taper


Fed looks at treasury purchases to keep rates low


Qe reinvented as treasury purchases. Fed Alchemy



Being Free's picture

I see dead people.

remain calm's picture

 Hold on to your powder boys and girls. The rippple effect in Japan will cause their the currency to collapse and the interest rates on the JGB to rise significantly.  Japan will be toast. the 10 year US treasury will fall to sub 1% as they and other nations look for a place to presevre their wealth. Bernanke is about to hand Yellen the biggest shit ball ever.

Yellen either watches sovereign nations defaults or restarts the mother load of all QE's. Either way gold goes to $5000-10,000, after a prior major retracement. Just be cool when the shit hits the fan and buy when things look bleakest, traders are jumping out of windows.

Fuck you federal reserve dick heads.

andrewp111's picture

You got a lot of moving parts in there. Some of them may happen without others.

And windows on Wall St skyscrapers do not open. You have to break very thick glass to jump out. Climbing the stairs to the roof is probably easier.

booboo's picture

Defaults are deflationary, just like the fed buying up every scrap of non performing asset paper. The fed is THE bad bank where all shit paper goes to die and why you keep scratching your noggin wondering when hyperinflation is going to manifest itself. As long as the fed is willing to remove the shit from circulation and keep it from blowing up and causing a chain reaction nothing is going to affect the market. Local Taxes will go hyper before your bread will.

SeattleBruce's picture

Deflationary depression or hyperinflationary depression. And we may get 'em both at different times thanks to the criminal behavior of the bankstas/FED.

Seasmoke's picture


FiatFapper's picture

Forgive my ignorance, but is FX currently risk off?

Namely AUDxxx & NZDxxx pairs (commodity currencies) are going down this week and USDxxx is going up (except USDCHF due to strong swissy), so why is SP500 making all time highs?

I'm confused by this disparity, how can dollar stengthen and SP500 make new highs?

Thanks in advance.