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Peng: Fed Tapering to What?

Secondly, and partly because of international hot money, there's clear evidence of equities, junk bonds, and housing prices in certain areas being in the bubble territory. The reason is clear from the yield chart above. The market seems unwilling to accept nominal 5Y treasury yield below 0.6%. Where does the liquidity go if not the treasuries? As always in financial bubbles, it starts to chase more risky assets.

But isn't the wealth effect from such bubbles supposed to trickle down and wake up the animal spirit? Yes, but only a small section of the society gets to benefit. Unlike the dot-com bubble, these bubbles are not driven by innovation and productivity increase. Only those with significant assets in such markets, or privileged access to liquidity (the upper end of capital chain, big banks), have a chance, hence the soaring suburban poverty .

Recently a Fed council of bankers warned of credit risk and asset bubbles, as reported by Bloomberg . While Bernanke tried to refute this Wednesday, the defense itself proves at least he's aware of the possibility. The bigger the bubble, the uglier it gets when the eventual Fed exit occurs. The taper talk is his attempt at managing the bubble. Nobody has succeeded in this feat. Good luck to you, Bernanke.

What's still more alarming is that even the big banks are being squeezed for collateral . General Collateral repo rate, which is a key rate in the vast inter-bank short-term funding market, going negative means banks are willing to borrow treasury bonds with more than 100 cents on the dollar, in cash. This betrays common sense, much as negative interest rates. In short it implies banks are desperate to either expand their speculative bets or avoid liquidation of existing positions. It often indicates extraordinary stress in banks. In this instance I'm not sure that's the case; it could just be that banks and their institutional clients are scrambling to get on the equities/junk-bonds/FX/new-CDO bandwagon. Regardless, however, the irony of banks running out of collateral in the era of practically unlimited liquidity is a strong testimony to unintended consequences of too much QE. After all, the Fed has swept up all the treasuries.
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