US Liquidity remains sky high on our indexes, which will underpin a strong economy this year. In contrast, China shows no signs of monetary easing (PBoC index 40.0) and the familiar further sight of weak overall Chinese liquidity (index 24.5) and weak cross-border capital flows to EM will add more downward pressure to Asian markets. However, what is lately a new sign is the sharp fall in Japanese private sector liquidity. We first noted this a month or two ago, but suggested then that it might be the benign accompaniment to domestic economic pick-up to the extent that it was reflecting a diversion of funds from the financial to the real economy. However, the recent appearance of poor monthly economic data may tell us that something else is underway, and perhaps the economic fall-out from a weak China is spreading? See latest Global Liquidity Update Report.

No surprise that latest PMI data shows Chinese economy weak. Our measure of Chinese liquidity flows which lead the economy have been depressed for part of 2012 and all of 2013. Without liquidity economies cannot grow and the China's PBoC has been deliberately squeezing for at least 18 months now. 4% rise in China's imports of crude oil in 2013 does not signal a rapidly growing economy. The domestic economy may not have a hard-landing but the rest of Asia and EM will. This is what the financial markets are currently trying to discount. Where does it end? (1) currency devaluations across EM; (2) renewed (imported) deflation in the West from later 2014, and (3) an EM debt/ banking crisis by 2016. As our research has suggested, buying US bonds in the later part of 2014 may make some sense. Liquidity matters...everywhere.

The outlook for our least favourite asset class in 2013 - TIPS - still looks poor. China's structural slowdown, in large part the result of tight PBoC liquidity hitting capex spending, will allow capital productivity in other economies, notably Japan and the US, to pick-up. This will push up World real interest rates from the circa 0% level nearer to their 2-3% long-term average. High inflation is not the threat; higher real interest rates are. This will push nominal bonds towards a 4-5% yield base. Equities still look the best asset class, but markets are ultimately moving towards a 1987-like ending. See report: How China Sets World Interest Rates (part II).