The Stock Is Dead, Long-Live The Flow: Perpetual QE Has Arrived

Tyler Durden's picture

Two months ago, as we were carefully reading the latest Goldman explanation of how the firm had completely missed something Zero Hedge predicted back in January, namely the record warm winter's impact on skewing seasonal adjustments for payroll data (which has since validated our day 1 of 2012 predication that 2012 will be a carbon-copy replica of 2011, and which has made the comedy value of another Goldman masterpiece, that of Jim O'Neill's idiotic "2012: Not a Repeat of 2010 or 2011" soar through the roof) we stumbled upon something we knew was about to get much, much more airplay: Goldman's quiet and out of place admission that what matters for a country's central bank is the flow of its purchases, not the stock (another massive economic misconception we have been trying to debunk since the beginning). Recall these words: "...we have found some evidence that at the very long end of the yield curve, where Operation Twist is concentrated, it may be not just the stock of securities held by the Fed but also the ongoing flow of purchases that matters for yields..." This is how we summarized this observation two months ago (pardon the all caps): "UNLESS THE FED IS ACTIVELY ENGAGING IN MONETIZATION AT EVERY GIVEN MOMENT, THE IMPACT FROM EASING DIMINISHES PROGRESSIVELY, ULTIMATELY APPROACHING ZERO AND SUBSEQUENTLY BECOMING NEGATIVE!"

All caps aside, what this means is simple: if it is indeed flow that matters (and it is), then Fed intervention can never stop, period. If the stock of a central banks' assets is irrelevant, the Fed can have $1 on the left side of the balance sheet or $1 quadrillion: it does not matter - if the market expects the Fed to stop buying assets tomorrow, then the crash is as good as here. That has precisely been the biggest flaw with the Fed-accepted stock model, per which Bernanke can buy up a few trillion in MBS and the stock market will be flat as a frozen lake. Alas, this is increasingly becoming obvious is not the case. Hence flow.

Which is why today, two months later, and a week before Bernanke will almost certainly announce the NEW QE, we were not surprised at all to see that Goldman has actually made the case for flow in the form a of a white paper titled "Flow Effects at the Ultra-Long end of the Curve."

For monetary theory purists this is equivalent to Martin Luther walking up to the front door of the Marriner Eccles building and nailing his 95 theses: we have now entered the era of the monetary reformation, which incidentally as more and more classical economists follow suit, will throw all of Keynesian and neo-classical economics into a tailspin where virtually every core assumption will have to be reevaluated.

Congratulations economists: in their pursuit of another record year of bonuses at any cost, Goldman just sacrificed your precious voodoo. Because where Goldman goes, everyone else promptly follows.

From Goldman Sachs:

Flow Effects at the Ultra-Long End of the Curve (Shan/Stehn)

  • With the scheduled end of the Fed's twist approaching, market participants are debating the extent to which the end of the Fed's purchases will affect the yield curve. The "stock view" – which Fed officials and we have generally subscribed to – suggests that markets tend to price in the Fed's purchases at announcement and then show little responsiveness to the subsequent flow (and end) of purchases. The "flow view," however, would suggest that yields increase when the twist concludes.
  • Using a simple model of the Treasury yield curve, we revisit this issue in today's daily. Our estimates suggest that the flow effect is negligible for short and intermediate maturities (of less than 20 years) but statistically significant at the ultra-long end of the curve (with maturities of 20+ years). Although the uncertainty is significant, these estimates suggest that – all else equal – the end of the twist will have negligible effects on the short and intermediate part of the curve, but might push up yields at the ultra-long end of the curve by around 5 basis points.

With the scheduled end of the Fed's twist approaching, market participants are debating the extent to which the end of the Fed's purchases will affect the yield curve. Economic theory suggests that we need to distinguish between the effects of the announced stock of Fed purchases and the flow of actual purchases. In forward-looking and liquid markets, bond yields should primarily depend on the announced stock of purchases. Therefore, markets should price in the size of the purchase program at announcement and show little response to the subsequent flow of purchases. This means that when the flow of Fed purchases is discontinued—but the size and duration of the Fed's balance sheet is unchanged—there should be little effect on yields. Empirical evidence has generally reinforced this prediction. Our own work, for example, has confirmed that stock effects dominate flow effects. (See Sven Jari Stehn, "Stocks vs. Flows Revisited: End of QE2 Unlikely To Have Significant Effect on Bond Yields," US Daily, April 13, 2011.)

Although the "stock view" appears to be a good description of the effects of Fed purchases at the short and intermediate maturities, flows might be more important at the ultra-long end of the Treasury curve. Intuitively, this would fit with the observation of investment habitat – how purchases of 20-30 year bonds are mostly conducted by more heterogeneous investors that are less sensitive to changes in demand and supply in the Treasury market. Consistent with this view, we found tentative evidence for flow effects at the ultra-long end of the curve in earlier work (see US Daily cited above). However, the number of observations was very small and so the estimates were very imprecise.

With more data on hand and the end of the twist in sight, we revisit the issue of flow effects from Fed asset purchases at the long end of the curve in today's daily.

Following our previous work, we focus not just on one particular point on the yield curve at a time but also explore how the Fed’s purchase program has affected the entire yield curve. Doing so allows us to better separate the effects of economic factors (which affect the entire yield curve) from the Fed purchases (which differ across the yield curve). Making use of the relative movement of yields at different maturities provides more information and should thus provide better identification. (This disaggregated approach is motivated by Stefania D’Amico and Thomas King, “Flow and Stock Effects of Large-Scale Treasury Purchases,” Finance and Economics Discussion Series, Federal Reserve Board, 2010-52.)

Specifically, we construct our model in a number of steps.

First, we use the New York Fed’s Treasury yield curve estimates, which provide coupon-equivalent par yields for maturities between one year and 30 years.

Second, we construct a dataset of daily flows of Treasury purchases from the New York Fed’s website and allocate these into different “maturity buckets.” For example, we match purchases of bonds that have remaining maturity of between 9.5 and 10.5 years with the 10-year bond yield discussed above. Our sample period – which runs from March 2009 through April 2012 – can be divided into three phases: QE1 (March 2009 through October 2010), QE2 (November 2010 through August 2011), and the twist (since September 2011). The distribution of the purchases is shown in Exhibit 1 below.

Third, we control for the announced stock of Treasury purchases. Given our focus on testing for flow effects and the difficulty of identifying the announcement effect at individual maturities, we use a very flexible approach to capture the effect of the stock of purchases on yields. (Specifically, we use an intercept dummy and a linear trend for each maturity bucket in each QE phase.) The advantage of this approach is that we do not have to make a priori assumptions on the magnitude of the stock effect and doing so should raise the bar for finding flow effects. The drawback, of course, is that our model focuses solely on generating a flow estimate and cannot provide an estimate for the magnitude of the stock effect.

Finally, we combine the data on yields and flows with our stock dummy variables to construct a panel model for these thirty maturity buckets with daily data since March 2009. To take into account variations in duration and/or liquidity factors across maturity buckets, we allow the constant in our model to vary across maturities (that is, we include so-called maturity “fixed effects”). And to disentangle the effect of the Fed’s purchases at the different maturity buckets from economic factors that affect yields across the maturity spectrum, we allow the whole yield curve to shift over time (that is, we include so-called “time fixed effects”). In a nutshell, we estimate the following panel regression:

yield = ?*flow + ?*stock+ fixed effects

where the flow variable captures the purchases, the stock variable is given by the dummies described above and the fixed effects represent maturity and time fixed effects as discussed above. If there is a flow effect, then we should find a negative ? in this regression. To explore whether the flow effect differs at different parts of the curve, we allow ? to vary across different maturity buckets. In our baseline specification, we split the yield curve into seven segments (namely, 1-2 years, 3-4, 5-7, 8-10, 11-14, 15-20, and 21-30 years).

Our results are summarized in Exhibit 2 below. (For the full set of details, see Table 1 in the appendix). Our estimates reveal statistically insignificant ? coefficients at the short and intermediate maturities (up to 20 years), but negative and statistically significant estimates of ? at the ultra-long end of the curve (with 21-30 years maturity). In other words, our estimates confirm previous findings that the flow effect is negligible for short and intermediate maturities but significant at the ultra-long end of the curve. In terms of magnitudes, our results suggest that a $1bn purchase at the ultra-long end of the curve (all other things equal) lowers the yield by 3.3bp at that part of the curve.

We performed a few robustness checks. First, we split the regressions for the 1-10 maturities and 11-30 maturities in two regressions to address the concern that the daily time effects are not appropriate when grouping all 30 maturities together in one regression. The results are qualitatively similar: the flow effect at the very long end of the curve remains significant but the size of the effect drops from 3.3 to 2.3bp per $1bn (see Table 1 in the appendix). Second, we omitted the 1-2 years and 1-3 years maturities since the yields of these maturities have effectively been pinned down by the Fed's guidance language. Again the results are qualitatively unchanged (not shown).

In a final step, we can look at the implication of our estimates for the yield curve should the twist end in June as currently scheduled. As discussed, our model suggests that – all other things equal – we should not expect to see significant effects on the short and intermediate parts of the yield curve. But – again all other things equal – our model would point to an increase in yields at the ultra-long end of the curve. A simple approach to gauging the implied magnitude of this effect is to look at the average monthly purchases at this part of the curve over the last few months and ask by how much yields would move if this dried up. The Fed has purchased around $13bn per month at the ultra-long end of the curve (21-30 years) since the start of the twist. Taking into account that no purchases were actually made at the 21-23 year maturity (see Exhibit 1 above), this comes to an average of around $1.8bn per month in each of the maturity buckets where purchases actually took place. Applying our estimates of the flow effect – the 2.3bp to 3.3bp range per $1bn of purchases – this would imply that an increase in yields at the ultra-long end of the curve of around 5bp.

While we have reasonable confidence in the qualitative conclusion of our analysis – that flows tend to perturb yields only at the ultra-long end of the curve – it is important to keep in mind a number of caveats when interpreting the quantitative implications of our model. First, disentangling the influence of stocks, flows and other variables on the yield curve is a very difficult exercise and the uncertainty is therefore considerable. Second, our estimated magnitudes are only about as large as the average daily volatility of yields over the last three years (around 6bp at the 30-year maturity). Finally, it is important to note that our model's estimate only refers to the effect of the end of the flow of purchases on yields and does not take into account other factors that might influence yields at the same time. For example, the end of the twist could have a significant effect on the yield curve beyond the analysis presented here if Fed officials deliver something different from what the market is expecting for the June meeting

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Michael's picture

The Federal Reserve is a private corporation. The more it loads up on toxic assets on behalf of its member bank owners, the more worthless its private banking cartel becomes, thus paving the way for its own destruction.

QE to infinity and beyond I say Ben.  

Harlequin001's picture

I don't get it. This is common sense is it not?

If no one is buying then an asset  has no resale value does it not?

Talk about 'bullshit baffles brains', and there's plenty of bullshit in here, or am I missing something...

CommunityStandard's picture

Correct.  If one party buys up most of the asset, the price for the asset will stay high... until the party tries to sell.  This is what killed JPM with the failwhale trade.

Bonds work a little different because even if the price collapses, you can still hold to maturity and get full return of principal with interest along the way.  Which is one reason why there won't be much change in short term yields, as you don't have long to wait to get your money back.  It WILL make a big difference in long term yields.

The Big Ching-aso's picture



The Fed's not gonna ultimately eat the big wiener.  I think 401k's & IRA's ultimately will.  No giant private corp that I know of commits altruistic suicide.

Shocker's picture

Lets talk when there is QE4, QE5.

QE3 is already done and over

Harlequin001's picture

The simple explanation I believe, is that when you examine the events surrounding and leading up to Weimar, and without going into too much detail, there must always be sufficient cash in an economy to liquidate bonds at par, and by that I mean all of them if necessary. If there isn't, then bonds are sold for whatever cash you can get for them, i.e. at a loss, and thus higher yield. Since all bonds will revalue in line with the new yields, or at least should do the important thing to watch is always the quantum of bonds in issue relative to cash available to liquidate them. Whilst the Fed can bluster all it wants, it either prints sufficient to allow bonds to liquidate at par, or self destructs with it's commensurate higher costs through higher yields. When you consider how many of these bailouts are being funded by already over issued bonds, and the liquidity problems we already have in trying to liquidate at par, the bond markets either blow up individually leading to the collapse of individual governments one after another if they don't print, (and no self respecting politician is ever going to accept that), or they all blow up in one go if they do, (which is by far more preferable) in which case all central banks need to print massively and simultaneously and we deal with the currency problems later.

There is already no alternative to that. You'll see QE100 if the market doesn't fail long before it, which it will, but not yet.

Whichever way you look at it, the bond market is toast. So unless Bernanke is actively buying the long end with CASH and not more debt issuance, neither flow nor stock have any real relevance because default is ultimately unavoidable since we are exacerbating the same problem that started it i.e. a lack of cash to liquidate at par because there are too many bonds waiting to be sold. The bond markets will never recover from this because they cannot. The instant the Fed stops buying everything fails, and they, and we know it.

It doesn't help that prices have already been distorted beyond comprehension, including pm's, which are far too cheap at these prices when you consider how much cash MUST yet be produced.

'To QE or not to QE' is really not an option...

SafelyGraze's picture

" So unless Bernanke is actively buying the long end with CASH and not more debt issuance, "

you lost me at "cash"

does Bernanke have access to "cash" that is other than "debt issuance"?

is his "cash" an asset or a liability of the federal reserve?

CommunityStandard's picture

Yeah.  Corps have a LOT of cash sitting in their accounts, but they'll only be in short term.  A lot of mutual funds, pensions, foundations, and endowments own t-bonds, which would take a beating should the easing stop.

Sam Clemons's picture

Unless stock markets take a beating.  Is it worth cutting off your hand to save your arm?

CommunityStandard's picture

I have to remember when I post here to make extra clear that I am not expressing or implying an opinion when I state fact.  Yes, bonds will lose value should easing stop.  Despite this, I DO NOT SUPPORT FURTHER EASING.  Nor am I saying these accounts should move into equities.

Sudden Debt's picture

As the Yakuza would say: Let's start with your pinky and see how we'll move along for the rest of the day...

BooMushroom's picture

Do they have cash in their accounts, or do they have a whole lot of ones and zeros?

mcguire's picture

i think im on the same page as you.   why would flow matter, and not stock?  is it because the flow of purchases by the Fed lets you know that there will always be a buyer of 'last resort' there???  

if so, is this a reflection of the volatility and liquidity at that end of the yeild curve???  

potlatch's picture

at the end, is a wall of noise screaming Fiat! Bitchez!  Wonder how long that yell can last?  It will run out of its animal spirit sooner or later.

CommunityStandard's picture

While you wouldn't call them a buyer of 'last resort', your line of thinking is accurate.  Treasuries are offered at auction.  If you are a firm buying treasuries for your clients who want them, and the Fed comes in and buys up 60% of them, you now have to compete for the remaining ones and accept lower yields.

That's why flow is more important than stock - it doesn't matter how many t-bonds the government owns.  Once the Fed stops buying up bonds at auction, there's more supply, hence the higher yields.

Go Tribe's picture

Yep. As long as there is one more sucker to buy, that sucker will be the fed, and all things are good.

potlatch's picture

isn't that one of the classic problems in set theory?

WmMcK's picture

Still fuzzy on that ...

potlatch's picture

Fed = a set that continuously tries to not include itself in the set

Harlequin001's picture

So, England owns the Fed, oh yeah...

QuantumCat's picture

Precisely.  However, game theory tells me the Fed will pursue this only as long as needed to outlast the Euro and the Yuan. The FRN is the supreme debt slave currency with oceans of debt many orders of magnitude beyond all other currencies. Why kill the golden goose?    

RECISION's picture


This is a - I can last longer than you - game.

Cult_of_Reason's picture

Germany signals shift on €2.3 trillion redemption fund for Europe

 The German government has begun opening the door to shared debts for the first time in a profound change of policy, agreeing to explore proposals for a €2.3 trillion (£1.9 trillion) stabilization fund in order to stop the eurozone’s crisis escalating out of control.

Officials in Berlin say privately that Chancellor Angela Merkel is willing to drop her vehement opposition to plans for a "European Redemption Pact", a "sinking fund" that would pay down excess sovereign debt in the eurozone.

jimmyjames's picture

Officials in Berlin say privately that Chancellor Angela Merkel is willing to drop her vehement opposition to plans for a "European Redemption Pact"


Maybe this little enticement changed her view-


Experts say this overlooks the tough conditionality. Italy and other states would have to pledge gold and other forms of collateral equal to 20pc of their debt in the fund.

"The assets could be taken from the country's currency and gold reserves. The collateral nominated would only be used in the event that a country does not meet its payment obligations," said the proposal.


How can those countries ever grow and tax their way out in these economic conditions?

They can kiss their gold reserves good-bye and then watch their bond yields rip-

Matt's picture

It depends on what they do with this program; if they buy everyone's debt down to 1 percent yield, things will be peachy.

Are they sure 2.3 trillion is enough? Let's just get this fixed once and for all, make it at least 20 trillion to be sure, as a one-time bailout atom bomb.

MsCreant's picture

20% is enough if gold goes through the roof. Lure them out, SUUUUUUEEEEE! Here PIIGS, PIIGS, PIIGS. Man this is a tense game of chess.


BooMushroom's picture

So they pledge the assets. Then they default. Germany says, "oh, that's too bad - we'll take those assets pledged as collateral."
And the PIIGS reply:
"Molon Labe."

Then what?

Matt's picture

You think the PIIGS gold are in their own vaults? You don't think they are sitting in London, New York and Switzerland? Or if they are holding their own gold, do you want to bet that as part of the conditions, the gold pledged for backstopping the debts will not be required to be moved into above mentioned vaults?

world_debt_slave's picture
1. Ne4 d2
2. Nf6+ Kh8
3. Ne7 (if Black did not have the pawn at this point, the game would be a draw because of stalemate)
3... d1=Q
4. Ng6#

If Black did not have the pawn move available, White could not force checkmate.

MsCreant's picture

I posted a chess thing before reading your post. Only maybe a game of Chest, as in treasure chest.

MunX's picture

Oh yeah now I remember calculus. Exponential functions have limits. Sorry I forgot.


Future Ben Bernanke Quote.

SeattleBruce's picture

Mind reminding Krugman, Obummer, and Mittens of that while you're at it?

Snakeeyes's picture

I agree. But it also means that The Fed will be purchasing assets that it was NEVER intended to purchase. See chart for details of things other than Treasuries.

This means MORE MBS, bad credit paper, etc. The Fed will be a toxic waste dump.


tekhneek's picture

If Ben Bernanke was on Dancing With The Stars we'd already be using a commodity based currency, unfortunately people have no idea what the Federal Reserve is.

Maybe that's the plan? At the end of this charade the Fed files bankruptcy and admits their "money" is bullshit thus removing all wealth globally?

Who knows. Sometimes I have a hard time wrapping my head around why a lot of this stuff is happening and then there's moments of clarity... followed by alcohol.

Dr. Richard Head's picture

Alcohol is what I use kill the Buddha I meet in the road. The actions taking place in these financial intermediaries is the strangest game of musical circle jerks I have ever seen...intention based on what and why is hard to understand anymore.

Raisuli's picture

Uh, what is the Federal Reserve? JK. What is wealth? Not Kidding.

MsCreant's picture

Bad bank. Naughty bank. Spankies for you.

stocktivity's picture

Greek election too close to call. Who will have the guts to hold over the weekend. Could be up or down 400 - 500 points Monday. I smell a sell off Friday.

Christoph830's picture

I don't think the upside and downside are of equivalent magnitudes.  Attention has already shifted to Spain/Italy and France is on deck which will all but negate the upside from a New Democracy party victory in Greece.  I believe a New Democracy win would be good for a 200-300 pt pop on the Dow but it will be short-lived.  IMO, a victory by Syriza could signal the 400-500 pt drop you are talking about.  That being said, this drop would also be short-lived as I believe it would prompt the Fed to do something drastic to prop up the "market."  The prudent move would probably be to stay all-cash for now but if you want to go for the homerun, I'd be short going into the weekend.

Poor Grogman's picture

I wonder how the private shareholders of the FED feel about being the eventual future owners of most of the encumbered assets in the western world.

Oh disregard, I forgot..

That was the plan all along....

merizobeach's picture

Bingo.  It doesn't matter to the Fed how 'toxic' it all is so long as they eventually own everything.

IMA5U's picture

Just imagine if the Fed dissapoints next week

CommunityStandard's picture

It'll be crazy.  So sad that since the Fed has gotten involved, it's going to stay involved to avoid tanking everything.

Sophist Economicus's picture

"So sad that since the Fed has gotten involved..."

They've been actively involved since WWI