Summary

Michael focused his Conference Call on understanding the movements of global liquidity and capital flows in a consistent way, through his developed frameworks originating from years at Salomon Brothers. Global liquidity currently sits at about US$160 trillion, about twice global GDP, compared to 20 years ago where global liquidity was 1x GDP, showing the growth and increased importance. Over time, the biggest shares of global liquidity have moved away from Europe and the US, and towards Asia and China in particular. CrossBorder use their Global Liquidity Index to understand these flows by looking at the momentum of liquidity. Looking at measures of capital flows into the US can give a good one-year indication of what the DXY will do, as private Sector-less Central Bank liquidity parallels with excess demand for a currency. Michael predicts a slowdown in economies over the next 6 to 12 months, with the Global Liquidity Index running 9 months ahead and trending down compared to the World Business Cycle graph. Looking at the three big central banks, there has been an inflection starting late 2020. 85% of increased liquidity in the past 3 months has come from the Fed and the ECB, with other entities tailing off. Looking at the Fed, the increase in reverse repos has dented the growth of base money significantly, showing a tightening or slowing down of liquidity. Michael predicts the Fed has implemented these policies to slow growth in the balance sheet prior to making a definitive statement on the QE program in November/December of this year.

Looking at the collateral pool, there have been a number of interruptions over some time. The last 18 months has seen a huge loss of collateral, largely because the Federal Reserve has come in and used QE purchases to dent it. The amount of debt issuance that has come in since the GFC has been minimal, which Michael believes explains why interest rates are so low., with the overriding factor of shortage of safe assets out there, disturbing the financial system.

Moving on to discuss the symbiotic relationship between debt and liquidity, going back to 1980 there has always been one for one growth between liquidity and world debt, with both needing one another – with more quality debt, the more liquidity available. Secondly, debt must be refinanced, and with debt rolling over each year, requiring a large balance sheet, determined by balance sheet capacity and liquidity.

Looking at the Bullard chart, when James Bullard said there is great danger in cutting interest rates, with the risk of shifting from the top to the bottom left. The more that we cut interest rates, the more we're going to get into a disinflationary debt trap. The more disinflation from cutting interest rates, the more embedded into the lower left-hand corner of the chart, from an overload of debt. To manage liquidity, the best thing is to lend heavily, at high interest rates. Currently, policymakers are lending at low interest rates, causing an uptick of debt and dragging economic growth. Equity holdings to liquidity show that liquidity may be declining, and CrossBorder fear a short-term correction in the markets. With regards to the Equity Markets, there are far fewer opportunities now compared to March 2020.

Michael believes over the last 10-15 years, the Term Premia has had a major effect on the bond market. QE periods seem to be associated with rising Term Premia. Comparing with the liquidity line, the relationship seems to follow well with the tips yield curve (between 10-5 years). Inflections in both curves occur at the same time period.

Looking at the US dollar, it currently lies above its long-term trend lines, which could lead to some downward reversion despite people’s optimism. From tracking capital flows, typically spikes in the demand for US assets or capital inflow, tends to be associated with a demand for safe assets from other regions. The latest COVID crisis money is coming to the US dollar and is one of the reasons why US asset prices are inflated. Official holdings of treasuries show numbers going down which questions the long-term integrity of the dollar.

Lastly, discussing China and the Asian region, currencies have basically flatlined since 2015/16, whereas the Euro and Dollar have fluctuated. This level of stability in Asian currency is almost unheard of to Michael, with Policy focusing far more on stability, noted from the Shanghai Accord which set aims to reduce the dollar. The focus is on stability, and countries in Asia are prepared to sacrifice economic growth to achieve currency stability. In daily economic readings, Asia has led the downturn compared to Europe and the Americas.

China makes up 30% of global liquidity, however looking at the effective contribution of China to global liquidity, it's much less as a lot of that Chinese liquidity doesn't circulate in the global economy, it's restricted to within China. US dollar liquidity is far more important to other economies, and shows China’s transmission in the world economy is much more through trade than capital flow or liquidity. Looking at World Business Confidence and the VIX, Michael warns there could be more disruption to equities markets as business confidence falters and the VIX lowers.

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