To This Day, the World Still Thinks It Was About QE
AP Photo/Karel Navarro, File
To This Day, the World Still Thinks It Was About QE
AP Photo/Karel Navarro, File
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It was like some huge thunderclap, an obvious disturbance which, by the end, contributed so much to how history unfolded. But like some unsolved cold case financial “crime” whose clues add up just short of recognizing the assailant, that day’s significance is assured even if all these years later I’ve yet to identify the culprit(s) or even establish exactly what had happened. This all took place on a date I doubt anyone really noticed, certainly not as it unfolded with confused and tortured history only beckoning the whole affair further into obscurity.

Obscure, sure, yet hardly trivial. The date was November 20, 2013. What did occur was already overshadowed by Economics getting it all wrong, that financial and money markets were experiencing some spasm of tantrum. Taper tantrum.

Federal Reserve Chairman Ben Bernanke had, purportedly, begun the whole thing by sitting in front of Congress back in May 2013 and floating his theory about a quickening economy fortified by monetary policy success being able to withstand scaling back the central bank pace for purchasing assets – both US Treasuries (which was QE4 begun in December 2012) as well as MBS (the actual QE3, announced months earlier in September 2012).

Much was made about the Treasuries; little as to mortgage securities. This was entirely understandable because unlike UST trading the way the market works (the way the sausage gets made) and how the Federal Reserve’s QE fit into it is nothing short of incomprehensible to the average person. Even (especially) the media talking heads.

Here, the Fed doesn’t just “buy bonds.”

Nor does any money dealer hoping to profit by putting together these mortgage-backed securities. Indeed, one of, if not the, whole point of splicing a pool of otherwise illiquid mortgage loans altogether in a single product is so that by the end of the process there ends up created a liquid instrument worthy of being repo-able. And the parts along the way are, too.

Repo, as you might have noticed in the years since Bear Stearns, comes up quite a lot and most often for reasons that have nothing to do with the Federal Reserve; or, put another way, appreciating the complexities in repo, especially relating to what truly goes on inside the collateral side of repo, makes one wonder how the Federal Reserve – or any modern central bank – might truly fit into the effective monetary system as it is.

While Summer 2013’s so-called taper tantrum focused on the UST side of things in mainstream attention, all that may have actually been a sideshow to the real trauma taking place over in MBS. This is not some minor marketplace, even years after the collapse of the 2000’s housing bubble, mortgage finance remained a monetary and financial centerpiece if chastened and diminished when compared to its pre-crisis reach.

By the end of June, the mortgage market was a whole mess; those few who noticed concentrated on, of course, the Fed’s pending taper. No. In an article published in Bloomberg on June 28, 2013 (Bonds Tied to Mortgages Poised for the Biggest Losses Since 1994), comparing the action in MBS to 1994’s “massacre”, there was instead this little noticed nugget more widely discussed by traders and insiders even if it never hit the mainstream media apart from whatever few mentions:

“The rout has been exacerbated by sales by real-estate investment trusts and other firms that rely on borrowed money that are seeking to pare rising leverage ratios, as well as adjustments tied to changes in the expected lives of the debt, a dynamic known as convexity…” [emphasis added]

The wider MBS marketplace requires obscene leverage, much if not most coming from repo markets, in order to properly function. This means dealers must stand ready to supply leverage in repo, including the use, re-use, or repledging of collateral which embraces, in MBS, something called the TBA market.

Before QE3 was ever announced, it had been widely expected to happen anyway (such was how bad QE2 and then Operation Twist had performed). Starting there, I wrote the following in mid-July 2013 as the MBS rout was still ongoing:

“The flood of anticipatory credit moved housing, especially multi-family, into a mini-bubble phase (in comparison to the previous episode). Once QE 3 was actually activated, the flood seems to have paused or stopped growing. There is no clear explanation as to why, but it seems like a combination of bad MBS liquidity (repo collateral and the collateral silo of QE) that formed a financing barrier against the pricing anomaly increasingly affecting ‘investment’ profit expectations.”

In other words, it was only a matter of time before things got out of hand. Unless the economy actually recovered – not just in a statistical sense brought about by the faulty and widely-recognized flawed unemployment rate – no dealer was going to sit back and be caught as the Greater Fool in providing MBS leverage to any number of banks and non-banks alike. The selling, once triggered, was almost guaranteed to get out of hand.

And, obviously, it didn’t matter how many bank reserves the Fed had “pumped” into the system; bank reserves rarely seriously matter for any of these problems.

When the time came during this “taper tantrum”, dealers disappeared as did any chance of collateral elasticity leaving repo markets and MBS leverage blasted; fire sales the inevitable result.

What was perhaps most shocking, though maybe it shouldn’t have been given close history (2011), was that damage refused to be contained in strictly mortgage-backed securities and the like. Oh no, instead, very much like 2008, it was the dealers who rejected these developments and began busily restructuring their entire books!

De-risking them. As I recalled in January 2019 about what should have happened if QE had achieved its aims:

“These [dealers] would shift mortgage personnel and balance sheet capacity from originating and underwriting subsidized (QE) mortgages to originating and underwriting consumer and business credit; dealers who were participating in the TBA market would shift money dealing activities to the plethora of opportunities a real recovery would provide an economy starved of it for half a decade by that point.” 

But that’s not what did happen; on the contrary: 

“Bernanke never expected banks to just pull out. It was the perfect storm for 2014. Once dealers started reassessing their embedded convexity risks (or risk more broadly) in MBS, they began doing so in all their books – starting with China and EM’s.”

It wasn’t just rising rates which hallmarked the “taper tantrum” era, concurrently would emerge an emerging market currency crisis blamed wrongly on those very same rising rates rather than the monetary shortage, or global dollar shortage, being reignited by global eurodollar dealers scaling back across-the-board.

With such a precarious monetary state, it brings us to November 20, 2013. Before then, early September, the eurodollar futures curve had already shifted; it began to compress all over again after only a few months of reflation, a very bearish and ominous signal from deep inside the system which foretold (correctly, as usual) of this same monetary tightness only becoming more fixed and difficult.

On November 20 itself, unless you followed the interest rate swap market you probably missed the fireworks; but they were fireworks, nonetheless, as I described less than a year after them. This fateful warning followed by one escalating event after another (this was indeed written just two days following the massive collateral alarm of October 15, 2014):

“If you actually trace that curve flattening, and this applies to every major curve segment, it all points to the same moment - November 20, 2013. To this day I have no idea what went on then, only that I am absolutely positive that something did. Start with swap spreads, as both the 5-year and 10-year spreads jerked into the negative on that day. Given the likely positioning of global dealers in swaps, who are the same entities counted on for providing liquidity, it doesn't take too far of a leap to see that the curve steepening (accompanying rising interest rates last year) was just too much to bear; somebody had a lot of risk to lay off with very few apparent takers.”

No longer strictly fears over convexity issues, dealers just disappeared from this key derivatives segment. The disturbance in systemic liquidity pushed swap spreads – the difference between the quoted price for the fixed leg of a vanilla interest rate swap and the nominal Treasury yield of the same maturity – back under zero, a deflationary, cautionary alert that something serious was seriously amiss having nothing to do with tapering QE and everything to do with lack of dealer capacities (either willingness or ability to extend systemic elasticity in every form, including interest rate swaps).

As I wrote in October 2014, the bearishness set in across the Treasury curve all pointed back to the events of that particular day; the yield curve shape, its calendar spreads particularly in the longer ends, they all peaked on November 20 gesturing toward a very different set of outcomes for 2014 and beyond than those pushing up QE taper.

Initially, at the very start of 2014, the yield curve and nominal yields along with eurodollar futures were the key indications. But, as I just wrote above, these were quickly joined by a plethora of bad omens which only accumulated as the year wore on.

Among the initial worrisome signals back in the first few months of 2014 was China’s currency. Settled conventional wisdom had it that CNY would only rise forever forward given how invulnerable China’s top-heavy, planned system was thought to have been (there’s always a mix of Western self-loathing along with authoritarian or technocratic envy in most conventional economic “analysis” when it comes to that side of the Pacific). Right from the start of the year, however, shocking in the sudden reverse of CNY’s direction.

Unable to explain it, still transfixed on the notion of omnipotent central banks – none believed more omnipresent than the People’s Bank of China – it was at first claimed that yuan’s sudden fall against the dollar was a product of intentional policy; the PBOC punishing speculators irritatingly betting against China’s fateful rise.

This idea was nurtured in no small part due to veiled hints and allegations issued by the PBOC itself. It was, like the previous year’s “taper tantrum”, playing upon the media and the public’s gross misconceptions about how the world actually works. I wrote in March 2014:

“What was the PBOC going to say, that they are experiencing desperate problems with dollar liquidity? They are going to proclaim, as all central banks do despite every evidence to the contrary, that they have everything under control, screaming like Kevin Bacon’s character in Animal House that ‘all is well’ even as evident chaos descends…In the Journal’s formulation, the PBOC is directing affairs, sending out ‘instructions’ that Chinese banks should ‘aggressively purchase dollars’ ostensibly to punish those hot money speculators…Is it not more likely that the PBOC has lost control of dollar conditions and was forced by the ‘market’ to widen the daily band in order for dollar-starved banks to aggressively bid for dollars they could not otherwise obtain?”

In fact, global bond yields, not strictly those of the US Treasury market, had moved in near-lockstep during 2014. German bunds, for instance, their 10-year instrument reached a local high on January 2 and then the yield dropped persistently, along with UST yields, throughout the coming year even as Germany itself never really reached any economic or recession danger.

It was the global system as a whole which tipped into the deflation for a third time, leaving some parts, especially China and Emerging Markets (the currency “crisis” of 2013 completely dwarfed by what came about starting in 2014), most vulnerable to suffering great economic harm all tracing back to whatever it was that happened on November 20, 2013; and what had actually and in reality led up to it.

The purpose of this review should be, I hope, painfully obvious in the context of July 2021. If not, then here’s the Atlanta Fed, only years later, in May of this year, finally coming around to acknowledge how bond yields around the world speak about conditions for a global system maybe as-yet not fully understood by central bankers but clear as day to those who aren’t captured by their inappropriately anachronistic worldview:

“This observation raises the possibility that domestic bond yields, including those in the large U.S. Treasury market, may be anchored by global economic developments, provision of global liquidity, and international markets arbitrage.”

Since mid-March 2021, US Treasury yields have topped out and over recent weeks have dropped considerably, moving starkly against badly-conceived general consensus about a whole range of issues only beginning with Jay Powell’s claim to, like Ben Bernanke, have flooded the world with digital dollars. It is technically true that the Fed has created a flood of bank reserves, but these are not in any functional way the same thing as effective money.

This should have been the lesson learned from 2013’s “taper tantrum.”

Not just UST yields of late, however, but bond yields all across the world are once more signaling the opposite of conventional inflationary expectations; the mistaken assumptions, like the illiquid environment, only ever repeat. Even the talk of tapering QE has returned to mainstream commentary, while that same commentary stands confused as to the how’s and why’s of a global bond market merely repeating itself (for a fifth time!)

Unlike November 20, 2013, however, if it does turn out that this year’s reflation was undone by monetary and economic problems spreading across the world then its nexus or inflection from back on February 25 was no mystery; this time, we know what happened. It may have taken the Treasury market a few more weeks to succumb, but “global factors” and global bonds all turned on that earlier date and remain anti-reflation to this day now four and a half months thereafter.

On February 24, as I’ve written repeatedly, Fedwire was inadvertently disrupted and in the process tripped up the dealer system which then led to a cascade of seemingly minor obstructions (culminating the 7-year UST auction on February 25) which in actuality amounted to an unnecessary reminder of what happens in effective money when dealers take a step back – like they had in the Summer and November of 2013.

Fragile rather than robust.

And to take things in the direction of escalating warnings, the dollar may be on the rise, too, including China’s yuan up more than a little since the end of May.

The idea that there might be “too much money” floating around is this year’s equivalent major mistake to associating everything in 2013 with taper. Bank reserves simply don’t play; dealer capacities and restraints are what make money. The dealer system itself, these global factors, are telling you everything you need to know about them; even if it is 180-degrees opposite of how it’s described in mainstream conversation.

After all, almost every single part of the QE3/4 story was and remains totally wrong to this day. Outside of a couple Atlanta Fed researchers looking more honestly at real evidence, the world still thinks it was about QE. That everything is about QE. While we don’t know what happened on November 20, 2013, specifically, we absolutely know why it happened and what it had actually meant. Then, as now.


Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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