Diagnosing Liquidity Addiction

Tyler Durden's picture

Over the last few weeks markets have recovered from the significant stresses that were building towards the end of May (until yesterday's slow realization). The recovery has been in no small part due to expectations of intervention and that fresh rounds of QE and their equivalents will soon be implemented around the developed world. Deutsche Bank believes that markets are now addicted to stimulus and can’t function properly without it as they show that the periods between central bank balance sheet activity have actually been fairly poor/average periods for risk assets over the last three years.

There is little evidence yet to suggest that markets in this post crisis world have the ability to prosper in a period without heavy intervention, though empirically asset prices benefit from liquidity but that the environment remains fragile enough for them to struggle to maintain their levels when the liquidity stops. Finally, they note that while QE in the US was partly implemented to bring long-term yields down to encourage investors into riskier assets and help lower borrowing/funding rates, the evidence is actually contrary to this.

Critically, they agree with us that the structural problems the West faces mean that QE and its equivalents and refinements will likely need to be around for several years to come to ensure that the financial system and its economies don’t relapse into a depressionary tail-spin. There is no evidence that we are currently close to being able to wean ourselves off our liquidity addiction. The hope would be that with further injections we can prevent the worst case scenario but the base case remains for the stress and intervention cycle repeating itself as far as the eye can see. Central banks still have much to do.


Deutsche Bank: A World Addicted To Liquidity

Risk assets before, during and after monetary stimulus in the US

Here we focus on the performance of risk assets through QE1 and QE2 as well as through Operation Twist. For each program we look not just at the actual announcement dates and program start and finish dates but also the date when it might be argued that further stimulus started to be priced in. Below in Figure 1 we provide a brief description for each of the three programs along with the relevant dates and explanations for those dates.

The Fed’s balance sheet

In Figure 2, we first take a look at the Fed’s balance sheet growth since the crisis started.

The shaded areas highlight the three phases of monetary stimulus that have taken place and we have split each of them into three sections, as described below.

  • The period where we have argued that QE/stimulus started to be expected until it was actually announced.
  • The period from the announcement date to the actual start date.
  • The period from the start date to the end date.

The first major step change occurred in the weeks immediately after the Lehman default where the Fed looked to provide short-term funding to the market as interbank lending ground to a halt. These facilities included the Primary Dealer Credit Facility, the Term Auction Facility, the foreign-exchange swaps with other central banks, the Commercial Paper Funding Facility and the various money market support facilities. After that, the two rounds of QE did see the balance sheet increase by several hundred Billion Dollars. However since QE2 officially ended on June 30th 2011 the Fed’s balance sheet has been broadly static which is understandable given that Operation Twist simply extends the duration of their balance sheet rather than increasing it.


Equities and credit performance

In Figure 3 and Figure 4 we look at the performance of equities and credit through each of the three distinct monetary stimulus programs. Highlighting these phases of stimulus as described above.

The take away from all three programs is that both credit and equities definitely seemed to benefit from the stimulus as in general risk assets had been quite weak leading up to the stimulus before generally performing through much of the stimulus period.

It’s also probably worth noting that the magnitude of the performance seems to have diminished with each round of QE/stimulus. Of perhaps more interest is that since QE2 ended almost exactly a year ago, the S&P 500 has essentially been flat. One would have to say that balance sheet expansion has been more risk positive than simply Twisting.


Commodities – Benefitting from balance sheet expansion but not from Twist?

The story for commodities is fairly interesting. As we can see in Figure 5, focusing on the CRB index, commodities certainly seemed to benefit from the liquidity boost provided by both QE1 and QE2.

It’s also interesting to note towards the end of both QE1 and QE2 commodities started to weaken quite aggressively perhaps indicating their correlation to actual injections of liquidity. Indeed the period around Operation Twist has seen the CRB index fall by around 20%.

Perhaps this is not entirely surprising. If our hypothesis about liquidity being the main reason for the rally during QE1 and QE2 then the fact that Operation Twist didn’t actually add any more liquidity could be a key reason for the lack of positive momentum for commodities.


Treasuries – A confusing picture

With regards to 10 year Treasuries the picture is slightly more confusing. The original broad intention of QE was to bring down yields to encourage money into riskier assets and investments. Figure 6 shows that QE1 actually saw yields rise sharply from around 2% as speculation of QE started to 2.5% on the announcement to 4% as the first round ended. This perhaps shows that the market believed that QE was very positive for the economy which outweighed the reduction of supply of Treasuries in the market place.

Like with QE1, QE2 actually sent yields higher again to around 3.75% within 6 months as hope again prevailed that QE could restore health to the economy. However the data turned in early 2011 and yields fell back to around 3% by the time QE2 ended. Immediately after QE2 ended we then saw 10 year yields rally to below 1.65% in less than 3 months which repeated the extreme rally seen after QE1 ended.

This is pretty much where yields are today as Operation Twist hasn’t had any lasting impact on yields. So overall, although QE was supposed to lower yields, the two largest rallies of the last 3 years have occurred in the period between QE1 and QE2 and then the period between QE2 and Operation Twist.


The US economy before, during and after monetary stimulus

We now turn our attention to how the US economy has reacted to the various stimulus programs. In order to have a fairly timely indicator of economic activity we have used the ISM manufacturing PMI, showing its progression through the various stages of QE.

Focusing initially on QE1 we can see that the US economy saw a strong recovery based on the ISM as it rose from below 35 to around the 60 level. Where QE1 was very successful was that it pulled the economy out of a potential depressionary tailspin. For both QE2 and Operation Twist although the ISM has remained above the important 50 level throughout we have not seen the same kind of improvement in the PMI. In fact during QE2 it actually fell from around 60 to the low 50s where it broadly stands today.

Indeed if we look back through history this recovery is one of the weakest on record in spite of all the Fed actions, plus the three largest peacetime deficits in the US on record. Figure 8 reminds us that only the recovery of 1927 (that ran into the 1929 stock market crash) has been weaker than this one in Nominal GDP terms. This probably tells us that a) the structural problems that encouraged QE were much larger than most believed at the time and b) that QE has limited power to actually power growth forward in such an environment.

With regards to the European economy, it’s also interesting that the PMIs did pick up over the period of the LTROs before falling again immediately after their completion. Europe more than anyone is perhaps addicted and in need of constant intervention to prosper.

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TrainWreck1's picture

I'll drink to Liquidity Addiction!


GetZeeGold's picture



Gonna have to drive home......I'm way to screwed up to walk.


economics9698's picture

Friday, Jack Daniels already? 

GetZeeGold's picture



Well.....as you pointed out.....it is Fryday.

derek_vineyard's picture

the addicted is the last to realize or acknowledge the problem and will go to most any length to stay addicted---even death

El Oregonian's picture

Can we get liquidity injections intravenously?

vast-dom's picture

Attention: please copy and paste this article to The Fed directly at:








Peter Pan's picture

This liquidity addiction is the equivalent of drinking sea water in ever increasing quantities in the hope it will quench our thirst. We all know how that ends.

Stock Tips Investment's picture

That is another problem facing the world. The monetary authorities (FED, ECB, BOJ) we have "sold" the idea that all economic problems (as in Europe) are solved with greater liquidity. Consequently, countries do not make the effort to manage their accounts (or take a long time), hoping that this excess liquidity be able to maintain economic activity. The consequences can be far worse than those who are currently living.

mickeyman's picture

I thought it was more like heroin. You need ever increasing amounts of heroin to get the same high. And the withdrawal symptoms are a problem too. So keep increasing the dose until the inevitable happens.

gjp's picture

"central banks still have much to do"?  Did TD really write this?

Central banks are powerless to stop the eventual collapse of the debt pyramid, and their reckless rescue actions are counterproductive and inequetible in the extreme.  We agree on this right?  So maybe they thing they have much to do, but it is that very mindset that will ensure a spectacular demise.

franzpick's picture

...with further injections we can prevent the worst case scenario...

Further injections are the worst case scenario: eliminating legacy debt from the fed/gov't sponsored 30 year-plus credit binge so as to enable recovery - is the solution, as well as being old news.

TD, why is this misinformation here, clogging up the otherwise timely and informative posts and comments?

Burr's 2nd Shot's picture

Never trust a junkie.

GetZeeGold's picture



Probably shouldn't have elected one then I'm thinking.


Meet you all in the Choom Wagon.


fonzannoon's picture

2 questions...why would commodities weaken at the end of QE1 and QE2? It's not like they shrunk the balance sheet.. Also since the fed is going to end up eventually holding all long dated paper, can they hold that paper 20-30 years until maturity or would they eventually be selling and dumping it on the markets only contributing to the eventual sky rocketing of rates. If anyone wants to take a shot at these it's much appreciated.

GetZeeGold's picture



What exactly do you think they spent the QE cash on?


LawsofPhysics's picture

Ah, that would be debt servicing (i.e. capital mis-allocation and mal-investment).

economics9698's picture

From the Feds point of view they spend maybe 6 cents on the dollar printing.  If the asset makes 30 cents on the dollar they win.  The Fed prints.  All they have to do is make over the cost of printing to make a profit.

Get it?

DeadFred's picture

Hmm, I gather from this that if you prop something up it goes higher and if you pull the props away it goes lower...

Broomer's picture

"Critically, they agree with us that the structural problems the West faces mean that QE and its equivalents and refinements will likely need to be around for several years to come to ensure that the financial system and its economies don’t relapse into a depressionary tail-spin."

So it's print or die, right?

I need to stockpile more stuff in my bunker.

GetZeeGold's picture



So it's print or die, right?


That's pretty much it amigo.


LawsofPhysics's picture

print or die for the paper-pushers maybe.  Those of us that produce real  products and deliver real  services will be fine.  Those that spin paper instruments of financial destruction, guess what fuckers, time to reap what you have sewn.

TrainWreck1's picture

Problem is nobody wants to buy anything we do produce, everyone is waiting for the collapse, way too scared to spend.

You can see it everywhere from empty parking lots at shopping malls to sparse crowds at garage sales.

Not to mention credit has dried up - all that bailout money never made it to the little guys (like it was ever intended to, bastages)



LawsofPhysics's picture

You are correct sir.  In the absence of any rule of law or real consequences for bad behavior, possession is the law and all eCONomies become very local, very quickly.

Spastica Rex's picture

The epic struggle of centralized control - corporate, royal, bureaucratic; in the end, tyranny is tyranny.

duo's picture

If the GDP was calculated using a realistic (Pre 1992) inflation indicator, US GDP would be down about 30% from 2007.

economics9698's picture

The private sector is maybe 1% growth rate since 2007.

LawsofPhysics's picture

Based on the margins I am looking at.  The inflation numbers being reported are bogus, unless of course you don't need any food or fuel to do anything.  As far as I know plants and algae are the only organisms that can sit in the sun and recharge themselves.


Time for a chlorophyll tatoo?

mrktwtch2's picture

when they brought back mark to magic accounting in march of 09 the gig was up..they effectivly found a way to make the stockmarket go up despite bad fundamentals..if not for foodstamps we would have had souplines again..im not sure how much longer this charade can continue..but you have to start each day flat and trade with the trend for the day..the old rules dont apply anymore..hopefully someday they will..but until then..trade accordingly..

Rip van Wrinkle's picture

So how much do these schmucks get paid for writing umpteen pages of unreadable bullshit when four words sum it up and have for years: -


Quantatitive Easing to Infinity!!

Mercury's picture

The hope would be that with further injections we can prevent the worst case scenario but the base case remains for the stress and intervention cycle repeating itself as far as the eye can see. Central banks still have much to do.

...treating the symptoms, not the disease.

Although maybe a better analogy is QE = food stamps for capital markets.  A creeping entitlement (in both perception and intention) disguised as temporary assistance.

LawsofPhysics's picture

Correct, funny how no-one talks about the corporate welfare or all the stimulus money that venture capital firms got.

Burn it all fucking down, fine with me.  The sun will rise and at least then we find out precisely what the value of everyone's labor really is.

Reset bitchez, bring it.

lolmao500's picture


2 #Turkish Airforce pilots are now in the custody of #syria|n army intelligence after their fighter plane was shot down in Syrian airspace

JS1234's picture

If we had just let the banks fail and not passed TARP we would be well on our way to recovery now.

GetZeeGold's picture



.....and just how were they suppose to make money on that?


emersonreturn's picture

Could be time for a class action against the Fed?

yogibear's picture

Ben Bernanke and the fed are money printers by nature. The Federal Reserve's balance sheet will start to be in the double digits soon just to support the US borrowing.

Everyone and everything will be maxed out with debt, then what?  No more fools left in their Ponzi scheme will create quite a problem.

The 20 somethings are loaded with more and more school debt, so this minimizes them as future home buyers and large consumers. With overseas/global  wage arbitration this minimizes salary increases.


John Law Lives's picture

"Deutsche Bank believes that markets are now addicted to stimulus and can’t function properly without it."

Time to stop using the term, "market", and call it something else.

The "Junkie Bazaar" opens in 5 minutes...

search's picture

Maybe i'm on the cool aid but i don't buy this liquidity to impunity trajectory. They know ( Bernank et al ) that the monetary experiment has run its course and history is going to be very unkind. They plead for a fiscal handover because they can see the negative feedback loop by which liquidity addicts are turning into zombies. Pretty soon the catataxis will set in and the print fest US/ECB money as medium of exchange (double the medium and hope for the exchange) will see that the german perception of a store of value is not so ethereal, but a lesson learned the hard way. I think they see the writing on the wall and Ben is just jawboning further QE. Tell me how i'm mistaken zerohedgians.

ghostzapper's picture

I agree with you.  I feel that Bernanke and the ECB are currently executing a stategy to try and lower expectations for more money printing.  They did QE1, QE2, and QE3 (LTROs in Euroland).  They know it didn't create any meaningful long term help.  Now they want to put the pressure on policy makers to make something happen.  However, if/when markets do completely plummet Ben will be there to ride in as the knight in shining armor.  He knows he needs to keep the surprise element there and step in when he gets a lot of bang for his buck so to speak.


I love ZH as much as the next guy and there are dozens of reasons to own gold.  We can discuss those until the cows come home.  The reality is Gold could very well drift down to 1200ish.  At some point maybe there is a coordinated printfest where Benny says "ok nobody else would help I'll step in and show you who the boss is".  I'm just sayin'.  People here will likely fry me for saying Gold might not go straight up each and every week for the rest of one's life.

beentheredonethat's picture

At chicago they call the friday nite beer bash the "liquidity preference function" 

slewie the pi-rat's picture


this is just more bankster 'opinion-shaping' propadganda


search's picture

@ghostzapper: I love zerohedge too, it's the stage that gives me a voice because it rests on the early Constitution. And i'm sayin maybe you don't , or we don't get fried because we're typing stream of consciousness and America knows it needs that.

Snakeeyes's picture

Liquidity is useless. In the US, M2 Money Velocity has fallen to 1959 levels. NO LONGER EFFECTIVE OTHER THAN CREATING A MIRAGE OF SAFETY!


search's picture

Anyway, getting down to brass tax, we all know that a materially leveraged position is a grasping at straws, a wish for the old days. They ain't coming back. We live in times that value value, damned the reality catching up.

Excursionist's picture

Great charts, yet anything but conclusive.

People here accept as dogma that liquidity = higher risk asset prices, but I haven't yet come across a body of work that definititvely ties the two together.  Seemingly compelling evidence I've seen is circumstantial, typically relying on overlaying two or more variables on charts and saying, "See!  Look at the relationship.  Proof in pictures!"  Hardly evidence that would receive a passing grade in Stats 101...

Take LTRO1 and LTRO2 as examples.  It's not like institutional investors woke up one morning and found their leverage costs lower.  Certainly their access to leverage didn't increase in any meaningful way.

Key question:  If liquidity did begin driving risk assets upward (starting in mid-December 2011), then how exactly did a euro printed by the ECB during LTRO1/2 end up being used in a U.S.-based manager's order for buying SPY or ES futures?  All the interim steps for the euro remain a mystery to me in this butterfly effect, assuming there is one.

My best guess at this point is that global macro whales like Bridgewater Associates simply have Pavlovian-like reflexes, driven by their tricked out econometric models that say, "If variable X exhibits Y, then execute Z."  But the injection of liquidity into some second-tier Italian Bank eventually causing the S&P 500 to shoot upwards?  How?