The Market Has Never Been More Reliant On The Fed, Or About That "Catch-22" Taper

As has been made clear previously, the primary reason the Fed is concerned with reducing the amount of monthly liquidity Flow (i.e., the Taper) has nothing to do with the economy, or concerns related to the prevention of asset bubbles, and everything to do with the fear that as it extracts ever more collateral out of the market, and transfers increasingly more Treasurys out of private hands and into its infinite "pseudo-public" balance sheet, the liquidity of the Treasury market will get increasingly more distorted and fragile. After all, recall that the Fed is currently monetizing 10% of all outstanding marketable debt stock in 10 year equivalent terms each year which also happens to be the hard ceiling on duration monetization. But as market events in the past two weeks reminded us, there is a flip side to that: now that the Fed is into its 5 year of explicit market support and rate stabilization, the market simply has no clue how to operate should the Fed no longer be the core source of duration end-demand in a world in which deficit spending is now in its terminal exponential phase.

If there is one chart that shows just how addicted the market has become to the Fed's soothing monthly bond bid come hell or high water, it is the following. It shows that on a rolling 6 month average, the Fed is now responsible for monetizing a record 70% of all net supply measured in 10 year equivalents. This represents a reliance on the Fed that is greater than ever before in history!

It is somehow in this environment - when the Fed is monetizing more duration than ever on a relative basis - that the Fed believes it can wean the market off its support: a market that has never been more reliant on the Fed than it is now.

And, hence, the Fed's Catch-22: damned if you taper, damned if you don't.