What Liquidity Events to Watch For In 2014

by Michael J. Howell3. January 2014 10:13
US monetary 'tapering' was the most talked about story in 2013, but in the event it proved the least important. The same may be true in 2014. The two big events last year were: (1) the success of QE ('quantitative easing') in driving Private Sector liquidity higher in the US, UK, Australia, Canada and Japan, and (2) the fallout across EM from Chinese PBoC 'tapering'. These made for a very 'normal' cycle in the DM and for an unusual one for EM, which despite the pick-up in the Global Economy suffered another sell-off. DM are being driven by their private sectors and not by policy-makers; ironically, it is EM that need policy support. There are four things to look out for in 2014: # positive effect of US shale oil on US flow of funds and US dollar # signs that 'normal' DM cycle continues with a capex revival and negative turning point in credit markets # evidence that Abenomics is continuing to work in Japan # persistence of 'tight' monetary policies in China We accept that the two most out-of-favour asset classes are gold and EM equities, but it still may be too early to jump back in. China needs to adjust away from its heavy bias towards capex and this will be a multi-year transition and runs similar risks to that experienced by the Soviet Economy in the 1980s when it too tried to change. China is capital abundant but energy short: not a good mix. Gold's fate is tied up with the US dollar and with the shale oil boom adding so much to US liquidity and the Fed more like to trim QE than not, the greenback could be in short-supply. This is the greatest risk in 2014. Already the rise in its 'sister' Sterling suggests a firmer dollar ahead. A stronger US dollar is not great news for EM, but it is better news for Europe and Japan. Japan will be a barometer in 2014 partly because Abenomics needs to work and partly because Japan is benefitting from a weak China. If Japan fails to get traction, it could warn that the World return on capital is again coming under pressure. This may compromise any capex recovery in DM; push down real interest rates and bash down risk appetite. All told, with the Global Liquidity cycle at or near a peak 2014 is likely to be a positive year, but it will definitely also be more volatile.

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