Another View Of QE's Demolition

by: Alhambra Investment Partners

By Jeffrey P. Snider

One last piece of evidence tying QE to liquidity disruptions in 2014, and the big buying "crash" of October 15, is the "flow" of "dollars" presented by TIC. My contention from last week was that the decay in systemic liquidity (repo) began not in May 2013 with the introduction of the "taper" concept, but a few months earlier when dealers may have recognized functional irregularities as eventually reversing QE-driven imbalances (especially what was until then a one-way, crowded trade in swaps). Swap spreads started to decompress months before anything else began to move negatively, including open-mouthed assertions from the FOMC that they were considering anything like ending the QE flood.

If we take the broader view of "dollar" liquidity to the foreign conception of the system, that February/March inflection in swaps trading is every bit as visible and obvious in TIC.

As I have said before, there has been a systemic shift in the global dollar short going all the way back to August 9, 2007. That has not been linear, but rather a stepped process with the next visible disruption that begins just as swap spreads change. As it was, the "dollar" disruption was quite immense even in historic comparison with the prior-panic and near-panics (like 2011). That "transmission" of changing leverage availability and liquidity perceptions is why, in my analysis, the eventual introduction of the "taper" idea produced vastly asymmetric results.

In other words, the foundation was already deficient and eroded by the time the Fed pushed the whole thing over the edge last May. That just confirmed what "market" participants were already afraid of, largely because that had been heavily positioned in the opposite direction due in full part to impressions of Bernanke from September 2012.

Eventually central banks around the world were "forced" to step in with various sundry, orthodox and mechanical countermeasures, but, again in the context of what started in 2007, the damage had already been done. "Dollar" participation and apparent "flow" has not returned to even what it was before February and March 2013 - meaning that systemic liquidity from the euro-dollar part of the equation has been devolved significantly. The change in liquidity behavior from the pre-crisis period until now is simply stunning, with a third major shift again just as the 2013 selloff takes place.

Taken together with dealers that have moved resources away from FICC and liquidity providing activities, it is no wonder the Treasury Department is warning of further liquidity episodes like October 15. The important point here is to emphasize that as reality in conjunction with how and why this most recent liquidity degradation came about - QE.