It was back in 2012 that Zero Hedge first warned about a topic that now has not only the buyside, but also prominent pundits, regulators and - ironically - even the Federal Reserve scrambling: the collapse of Treasury liquidity, manifested in the multiple-sigma, i.e. "flash crash (or smash)" moves in the Japanese JGB [7], the US Treasury [8]and most recently the German Bund markets [9].
What we said, and what it has taken the mainstream some 3 years to figure out, is that the primary culprit for the collapse in sovereign bond market liquidity are the central banks themselves, first the Fed, then the BOJ, and now, the ECB. Because as we noted in September 2012, "here is a snapshot of the Fed's nominal holdings by CUSIP spread by maturity. Some may be surprised that the Fed already owns 70%, or the maximum allowed without the Fed destroying all liquidity in a given CUSIP, in various issues, primarily in the 7-10 year window."
Before:
[10]
... and After (as of 2012):
[11]
Unfortunately, while the Fed's holdings expressed in 10 Year duration terms have so far peaked at around 35% of total, a level which many expected wouldn't be dire enough to lead to the evaporation of bond market depth also known as liquidity, what happened since then is that coupled with the surge of HFTs in bond market trading which contrary to popular opinion not only doesn't provide, but soaks up liquidity, as can be seen on the Nanex chart below...
OK Class, repeat after me: "Volume is NOT Liquidity".
This charts shows how they are related: pic.twitter.com/3wNWPeBIvJ [12]
— Eric Scott Hunsader (@nanexllc) May 9, 2015 [13]
... the 30% 10 Year duration threshold which had previously been greenlighted by the TBAC, ended up being far too high and as a result events such as the October 15 flash smash, and the May 2015 Bund flash crash, have become a normal and regular feature of the fragmented, central bank-manipulated and HFT-dominated markets.
So in case any readers have missed our constant coverage over the past 6 years, predicting accurately not only the breaking of markets due to the advent of HFTs, but the soaking up of all market liquidity by the Fed which in its increasingly more desperate attempts to reflate assets to record levels (remember when years ago it was blashpemy to suggest that the Federal Reserve is pushing the market higher - good times) has broken the markets even further and in fact made selling virtually impossible, thus trapping all those who have put their funds into the so called market, here is the chart showing how much bond market "depth" there is, or rather isn't, as a result of 6 years of Fed central planning.
The data comes courtesy of Stone McCarthy [14]:
The amount of ten-year equivalents held by the Fed decreased to $1.835 trillion from $1.849 trillion in the prior week, which reduces the amount available to the private sector to $3.944 trillion from $3.919 trillion in the prior week. There were $5.778 trillion ten-year equivalents outstanding, up from $5.768 trillion in the prior week.
After the Treasury issuance, maturing securities, rising interest rates, and Fed operations during the week, the Fed owned about 32.05% of the total outstanding ten year equivalents. This is above the 32.03% from the prior week, and the percentage of ten-year equivalents available to the private sector decreased to 67.95% from 67.97% in the prior week.
And here is a visual representation showing how much of the entire bond market expressed in 10 Year equivalents is now held by the Federal Reserve: a chart regular Zero Hedge users have seen consistently over the past 3 years.
[15]
The chart above also explains why absent a massive debt-funded government spending campaign, the Fed will be unable to launch QE4, for the simple reason that QE, which is nothing more than the Fed's deficit-funding coupled with a boosting of asset prices via the outside money reserve channel, would promptly soak up all the remaining bond market depth, and even as the S&P hit all time highs, it would lead the government bond market to terminal instability.
Which is why, paradoxically, for the status quo to persist, either the government will have to lower taxes which would require far greater debt issuance by the Treasury, and thus provide far more dry powder for the Fed to monetize, or the US will finally have to launch that deficit ballooning war it has been itching so hard to start since 2013.
That, or the Fed may finally realize that by reflating asset prices it does nothing to boost the actual economy as the S&P has and always will refuse to trickle down to the middle class, and the Fed will finally engage in what has been the endgame from day one: paradropping bricks of cash all over the continental US in the last ditch desperate effort to reflate a debt-load which has now pushed not only the US but the world into secular stagnation.
