Imagine: The Fed engages in another round of QE, and does a reverse dutch auction tender for Treasury securities. However, it's a "failed reverse auction." That is, they don't receive enough OFFERS from the Street! So the QE3 policy option door gets slammed shut by Mr. Market. Last week, this is what happened in Japan. (Eat your heart out JGB bears!) The BOJ printed yen and tried to use the fresh Yen to buy government debt from their banks. But the reverse auctions were under-subscribed. Politicians want the BOJ to dramatically expand their balance sheet. But they are seemingly unable to achieve this because JGB holders won't sell their paper and hold Yen. That this could happen in the midst of fiscal profligacy and massive debt/GDP raises many questions about macro economics not covered in textbooks or research papers.

Could this be a new twist on deflation and the long-term effects of ZIRP. Or might it reflect a fear on the part of investors that the central bank will impose a negative nominal interest rate on cash? Or perhaps it's some weird Japanese-market dynamic? Or perhaps its related to mandates and duration matching? Or that JGB's are safer than cash in the bank? Even Paul Krugman must be rubbing his eyes. Ultimately, I conclude that this must lead to the central bank buying other assets besides JGB's (and in fact they are buying other assets). But I recommend Specs give this situation some thought as it may be coming to a theater near you soon!





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