Does Size Really Matter?

by Michael J. Howell27. February 2013 10:46
According to latest market-talk the BoJ is the 'loosest' Central Bank worldwide simply because its balance sheet now stands at nearly 35% of GDP. Second is the ECB at 28%, while the BoE and the US Fed trail at 25% and 20%, respectively. Of course, this is absolute rubbish! Consider a counterfactual. A poor, cash-based economy, with no developed financial sector may well have a Central Bank balance sheet that is near 100% of GDP. Does this make it very loose? What matters here is the change in the size of the balance sheet. The last decade has (or should have) demonstrated that changes in the size of Central Bank balance sheets move risk premia on risk assets in the opposite direction. Thus QE policies reduce market risk and promote recovery. The size of Central Bank balance sheets relative to GDP is greater (1) the more that cash is used for trade; (2) the greater required reserves, and (3) the smaller the shadow banking sector. Hence, our point that this ratio cannot judge the stance of monetary policy. Rather it is a measure of financial development, if anything. Changes in absolute balance sheets matter way more. And, here is the main point. If the Fed had just shrunk its balance sheet by 15% would Wall Street still be at current levels, or would it be 20% maybe even 30% lower? Risk premia matter. Tell that to the ECB who have just let their balance sheet fall by 15%, and somehow (we scratch our heads) claim this is an easing. Watch out Eurozone!

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Big Week for the BoJ and...

by Michael J. Howell24. February 2013 22:58
Who becomes next BoJ Governor will likely be announced in coming days. The result may matter a lot to markets, at least as a signal. The BoJ has already expanded net liquidity provision well-above the critical Y40 trillion threshold. More importantly they have unusually done so when the Yen is weak. More, probably much more liquidity is coming. The Yen will drop further. Probably through Y100/US$: possibly to Y110/US$. A weaker Yen is part of our stronger US dollar story for 2013: it may also play a part in pushing the Eurozone towards another bout of financial volatility by squeezing competiveness another notch. In markets, there are no unrelated events.

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What Is Important?

by Michael J. Howell21. February 2013 11:34



We regularly monitor around 30 fund flow series for each of some 80 economies, monthly (and have done since the mid-1980s). These are available for clients to download from our website, and by using an Excel add-in. Which among these timeseries are the key pieces of liquidity data that investors need to focus on? Many have their own specific preferences, but here is our list of 13:



1.    Global Liquidity Cycle (GLI) is our 'headline' index published each month. This is a proven lead-indicator of prospects for risk assets. The series peaks during asset booms and troughs just ahead of banking crises. It leads the business and profit cycles by 12-15 months.


2.    US dollar area liquidity. This includes the liquidity cycles of those countries that use or shadow the US currency. It consistently and pro-cyclically leads the US Treasury 10-2 year yield curve by 3-6 months. More liquidity therefore raises the risk premium on government bonds and reduces the risk premia on other assets.


3.    Monetized US savings flows. This series defined as the difference between US private sector and Fed liquidity is an important lead indicator for the value of the US dollar. Greater Fed liquidity and fewer savings unambiguously weaken the US dollar around 6-12 months ahead.


4.    Emerging Market Liquidity Cycle. Like its developed economy counterpart this data series leads the reported earnings cycle of EM companies by around 18-24 months.


5.    Crossborder flows to EM. This important data series tracks the confidence of global capital and highlights the scale of inflows into EM securities. This is so often a lead indicator of EM outperformance.


6.    Central Bank policy indicators. In short, measures of 'effective' QE policies by the key Central Banks. We regularly compare the US Fed, the BoJ, the ECB, the SNB, the PBoC and the BoE.


7.    Investor exposure data showing the split between holdings of stocks and bonds. This balance sheet data which derive from the same sources as our flow data show actual holdings at each month-end. They are not investor sentiment surveys, but they serve as a robust measure of risk aversion.


8.    Investor exposure to EM against 'normal' benchmarks.


9.    Investor exposure to US dollar assets. This data is based on reported end-month balance sheet holdings of all US dollar financial assets. Shown as a normalised series as a proportion of all Worldwide financial wealth.


10.Ranking of liquidity conditions market-by-market each month.


11.Ranking of investors' exposure market-by-market each month.


12.Financial conditions (FCI) measures of short-term credit spreads across all 80 markets we monitor. This serves as a cross-check on our volume-based GLI.


13.World financial wealth (WFW) a US dollar aggregate of the value of all liquid asset holdings; listed stocks and listed government and corporate bonds across our databases.



Currency Wars Or Just Approaching Dollar Strength?

by Michael J. Howell20. February 2013 22:07
The most important decision we take is which currency to hold our wealth in. All else are just footnotes. In the long-term currency values are determined by productivity trends, but in the medium-term Central Banks and savings flows matter alot. The recent jump in forex volatility is understandable. A similar theme coloured the mid-to-late 1930s. As we have previous remarked, the French Franc was then very very strong until it was very very weak. The collapse in the Franc destroyed much of the wealth of France's then middle class. Eighty years on we are seeing another bout of competitive devaluations? Sterling is just the latest example. But why do so many seek to cheapen their exchange rates? We figure the reasons lie with the dollar. Not only has America become much more competitive over the past five years and able to compete with any EMs, but her liquidity and savings flows are strongly supportive of a rising US dollar. Two things are important here. First, unlike the QE1 and QE2 periods, QE3 will not see dollar weakness. Second, a strong dollar is the biggest threat that risk assets face in 2013. Surprisingly this threat gets little air time. Add up America's surging savings flows; the jump in wholesale funding by banks in the last 6 weeks; the shale oil boom and the narrowing current account deficit, and you may agree that the rest of us might soon be starved of dollars. If the latest FOMC minutes are taken at face value, a stronger economy ( its coming) will persuade policy-makers to slowdown QE3. At that point stand back and watch the dollar soar. Even gold, once everyone's friend, is now being shunned. The bottom line is that our Liquidity data has been warning for some months of coming dollar strength. It may just have arrived?

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GLI Update

by Michael J. Howell13. February 2013 17:29

January 2013 Global Liquidity Index (GLI) estimate at 57.8 ('normal' range 0-100) from 64.5 at end-2012. Global trend likely upwards, but ECB liquidity collapses. Full database released to clients. The GLI leads the business cycle by 12-15 months; equity markets by 9 months and bond and forex markets by 3-6 months.


More Sterling Problems?

by Michael J. Howell13. February 2013 12:21

When in trouble DEVALUE. This has been the response of British policy-makers through the past several decades. With the UK economy understandably fragile because of past imbalances and the Eurozone itself weak, British GDP growth is unlikely to step-up sufficiently to hand Prime Minister Cameron an Election win in two years time. The economy is still too structurally skewed towards financial services, housing and State spending. Chancellor Osborne is slated to cut State spending further, but cannot avoid further weakening demand. Therefore, the only option is weaker sterling and/ or more QE. They have appointed a new BoE Governor who is likely open to more US-style easing. Overall, the fall in sterling back to US$1.55/£ is understandable. Further weakness looks inevitable.

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ECB Headaches

by Michael J. Howell13. February 2013 12:19

We do not accept the argument that the ECBs operating procedures are so different from the Fed and the BoE that a drop in the size of their balance sheet can be read bullishly simply because it supposedly reflects less take-up of distressed borrowing by banks. Moreover, we cannot see how arguing that the EONIA lending rate lies ‘close’ to the deposit rate floor indicates abundant liquidity. First, ECB balance sheet contraction proved the critical signal for the last crisis and low EONIA rates did not help. Second, the Eurozone money markets are not functioning. Problem banks are still unable to get funding and are forced to borrow at higher rates. Third, in the post-Lehman Crisis World where Central Banks increasingly operate interest rate corridors between lending and deposit rates they are able to control both the level of interest rates and the volume of liquidity. In the US and UK, Central Bankers now realise that greater volumes of liquidity decrease market interest rates. Thus, by flooding the system with liquidity, the Fed has successfully pushed investors back into risk assets. In short, the volume of liquidity maters, and matters a lot. Falling ECB liquidity from E1.67 trillion to E1.5 trillion is thus a bearish and NOT a bullish sign.

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Another Eurozone Crisis Ahead?!

by Michael J. Howell11. February 2013 12:43
Both the ECB’s rhetoric and its actions are strangely out-of-step with the trends elsewhere. Eurozone is again heading for the buffers and the odds of another bout of market volatility have jumped according to our latest liquidity data. The ECBs monetary stance is strangely conventional at a time when more unconventional thinking is needed. Gross liquidity provision, which gives a better indication of support for Europe’s banks, slid back to E1.5 trillion in early February 2013 from E1.67 trillion last June, and the growth of base money has slowed sharply to pedestrian annual rates. More dramatically, our monthly index of ECB liquidity provision plunged to 6.3 (‘normal’ range 0-100) at end-January 2013 from a whopping 97.4 in June 2012. This has all the ‘fire-fighting’ hallmarks of the ECBs previous crisis responses: react to banking strains by throwing liquidity into markets and then progressively withdrawing it over following months as the crisis abates. Until the next time! We restate our end-2012 comment that, in our view, the risks in the Eurozone in 2013 far out-weight the potential rewards. This was not the case for 2012, where the reward/ risk ratio was extremely favourable and the chances of some ECB action high. The problem 12 months on is exacerbated by the recent Euro strength and notably the near 25% rally versus the Yen. Germany has been the rock that has supported fragile European business over the past year, but this latest loss of competitiveness will not help German export performance. Europe’s financial problems are all about lack funding rather than insolvency: a less active ECB and a declining pool of German savings will again heighten these problems.

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Dollar Strength?

by Michael J. Howell27. January 2013 15:59
Liquidity is unquestionably flowing but its mix points to US dollar strength and not dollar weakness as in QE1 and QE2 in 2009-11. A too strong US dollar is the major risk to our prediction of cyclical recovery this year, but some dollar strength in the second half of each cycle is normal. The Euro, despite recent rallies, looks to be in medium-term decline (as it must) by around 3-5% pa. What looks different is the behaviour of the Yen. Our latest research reports show BoJ activity and they make the point that BoJ easing in the face of Yen weakness is very unusual. In short, the Yen looks set to decline by around 5-10% pa. Adding this up the US dollar trade-weighted index may be set to appreciate by 3-5% pa. Not good news for gold in 2013 and a feature likely to restrain buoyant commodity prices.

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Has Gold Lost Its Glister?

by Michael J. Howell24. January 2013 18:58
Short answer: yes, temporarily. Three things are against gold in 2013; two things are are in its favour. We expect a cyclical business upturn, starting in the US and EM and touching (just) Europe this year. Risk on will be back in favour, so reducing the need to shelter in gold. Second, yield curves are set to steepen, forcing up yields and reducing the attractions of gold. Third, the huge build-up of private savings (much in the dollar area) versus the (surprising) slowness to print money, is rarely a bullish message for gold. For subscribers to our liquidity data this means high private sector liquidity (PSL) and relatively low Central Bank liquidity (CBL). Set against this are two big positives: first, gold is the reserve asset of choice, or at least number two following the Euro Crisis, for many EM Central Banks. This year like last year will see more bullion buying by them. Second,this debt crisis is not over. More, much more, monetization is needed and this will ultimately push gold towards our long-term target of US$3500/oz.

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