During QE2, the Fed’s purchases of Treasuries covered virtually 100% of new Treasury supply, freeing up cash that allowed the Primary Dealers (PDs) to speculate elsewhere. With the Fed now absorbing almost none of the new paper, the market faces an additional problem, and it is a huge one. Foreign central banks (FCBs) are now suddenly adding to supply, and not just a little.
Without Fed support, the dealers don’t have the luxury of mounting speculative buying campaigns, or even basic market support operations in equities or commodities. The only thing saving the Treasury market has been the run on European banks, bank paper, and sovereign debt. That cash has flooded into the Treasury market. When that ebbs, even a little, and with the FCBs now net sellers, Treasury supply could crush the PDs (who are obligated to buy it) forcing them to liquidate all types of financial assets in order to absorb the Treasury supply.
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