For The First Time Ever, QE Has Officially Failed

25-Jun (ZeroHedge) — Over two years ago in “Desperately Seeking $11.2 Trillion In Collateral”, Zero Hedge first warned that as a result of relentless central bank monetization of debt, liquidity in bond markets would decline at an ever faster pace even as, paradoxically, these same central banks added “phantom liquidity” (the topic of another post from two years ago) to equity markets in their attempt to artificially inflate stock prices to record levels without fundamental justification.

Sure enough, with the usual 2-5 year delay, in 2015 the primary financial topic sweeping the mainstream financial media and all the “serious” pundits, is the collapse in bond market liquidity.

Some, the more naive ones, blame regulation. Others, such as iconic Citigroup credit strategist Matt King strategist explained – once again – that Dodd Frank is a negligible reason for the total plunge in bond market liquidity which is the result of, just as we warned, central bank intervention and the relentless ascent of algorithmic trading.

But even as everyone is finally arguing about the cause of the plunging bond market liquidity and has no clue how to resolve this biggest nightmare for what once used to be the deepest and most liquidity of markets (at least not without forcing central banks to sell the trillions in bonds they hold, a step which would free up collateral but also result in the biggest market crash ever), a far more ominous question has reappeared. One which, as usual, we asked nearly three years ago: what happens when central banks soak up too much liquidity.

Our answer, at that point, QE will have officially failed, because instead of lowering bond yields – which as a reminder is the primary QE transmission mechanism, one which forces investor to reach not only for yield but also for risk in other asset classes such as equities – any incremental bond purchases will start raising yields as the adverse impact from the illiquidity “premium” surpasses the price appreciation benefit from frontrun central bank buying.

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PG View: When Fed governor Tarullo said earlier today expressed concerns about liquidity in the bond market drying up, he added tat it was unclear why it was happening. “I don’t think there is at this point a very precise and convincing explanation for exactly what has happened,” said Tarulla. Seems pretty obvious to me . . .