Global Liquidity Decoded
1. China and Japan are Important to the Global Liquidity Cycle:
China and Japan are key contributors to the global liquidity cycle.
Regarding their contributions to the global central bank balance sheet, global narrow money supply, and global FX reserves minus gold – the three metrics that we feature in the @42Macro Global Liquidity Proxy – China makes up ~20%, while Japan makes up ~15%. Understanding their liquidity cycles is vital in forecasting inflections in global liquidity.
2. The Chinese Liquidity Cycle Has a Big Impact on Asset Markets:
There’s a direct link between China’s liquidity and the global markets, including Bitcoin. Any significant shift in China’s liquidity, positive or negative, can considerably affect asset markets.
Our research shows that the Chinese economy shifted from adding approximately $1.5 trillion of liquidity in Q1 of this year to removing liquidity in the past few months. The pullback in Chinese liquidity coincides with #Bitcoin failing to continue its rally. We believe we will see another injection of liquidity into the Chinese economy; we just don’t believe it will happen in the short term.
3. Waning Public Sector Liquidity Provision in China:
The Chinese stock market is viewed as a reliable leading indicator of the country’s liquidity cycle because locals often have intelligence regarding future actions of the People’s Bank of China (PBOC).
We believe the recent decline in the Chinese stock market likely signals a decrease in China’s contributions to global liquidity over the medium term (because the market doesn’t anticipate a wave of liquidity from the PBOC).
4. Japan’s Liquidity Cycle Influences Bitcoin Too:
Like China, Japan’s liquidity cycle strongly correlates with Bitcoin and other risk assets.
Our research shows that in October of last year, the Japanese economy was removing $1.5 trillion from global liquidity on a three-month impulse basis.
In Q1 of this year, they shifted to add $2 trillion.
Because inflation is still very high in Japan, we do not foresee a liquidity injection from the BOJ in the near term.
5. It’s Not Just Enough to Monitor Global Liquidity; You Must Forecast It As Well:
The timeline for changes in liquidity inputs to manifest in outputs (values or liquidity changes) varies by the economy.
When an economy is at the bottom of its growth cycle (e.g., unemployment rising on a YoY basis, etc.), lead times are usually shorter because central banks will react with a sense of urgency to support their economies.
Conversely, factors like stock market performance and real interest rates in China may not trigger a similar sense of urgency by the PBOC and/or Chinese commercial banks.
Overall, the objective is to understand these dynamics to forecast the global liquidity impulse, which is currently negative. We believe this negative impulse is the reason Bitcoin hasn’t fully recovered its YTD high.
That’s a wrap!
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Whose portfolios are at risk over the next six months? The bulls or the bears?
1) The Bond markets are pricing in significant Federal Reserve easing in the coming 12-18 months.
In addition, the Fed Funds futures show easing is likely to start as early as November of this year.
But, our view on liquidity and factors in the real economy show that market positioning should change over the medium term.
As a result, we expect to see an increase in bond market volatility over the next quarter or two before we get into a recession.
2) The US consumer has been resilient.
Real PCE, which measures the value of goods and services purchased by households in the US, adjusted for inflation, is growing at twice its pre-covid trend.
Real Income is also growing at a three-month annualized rate of 7.6%.
The uptick in real PCE and Income signals increased demand for goods and services. This increase in demand can lead to higher prices, causing inflation to persist.
So, a resilient US consumer means sticky inflation.
3) The recession is likely to be delayed relative to investor consensus.
Many investors have been calling for a recession for over a year.
On top of that, many analysts are predicting negative GDP growth in the second quarter of the year.
But, our research shows the economy is resilient and will likely stay resilient until at least Q4.
And this delay could trap both bulls and bears, leading to significant volatility in both the stock and bond markets.
4) The AI bubble will eventually meet the wrong part of the Liquidity cycle.
The rise of AI is similar to the internet boom in the early 2000s. We could see a similar blow-off top in late-2023.
And while emerging technologies bring about significant societal changes, they don’t prevent market downturns. Investors would be wise to sell into strength later this year.
5) Is the bad news priced in? Are markets forward-looking?
We’ve backtested asset markets extensively and found that markets only look 2-3 months ahead at most.
Despite what people think, markets are more reactive than predictive.
And they’re most reactive to changing liquidity conditions. Since 2009, equity markets have been highly correlated to global liquidity.
Liquidity drives markets, and we believe the recovery in liquidity might not be as linear as many investors believe.
6) We expect a negative liquidity backdrop over the next few months.
We’ve probably seen a medium-term high in liquidity.
The expected increase in the Treasury General Account and the return to net coupon issuance by the US Treasury are negative for liquidity.
As a result, the Dollar could trend higher in the near term, harming #Bitcoin and other risk assets.
That’s a wrap!
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Have a great day
Rough Summer Ahead?
We joined Anthony Pompliano earlier this week to discuss the Debt Ceiling, Recession, Global Liquidity, and more.
Every investor will want to review the following six highlights from the interview:
1. We expect the Debt Limit Crisis to negatively impact global liquidity.
The US government will return to the international capital markets to borrow more money (after resolving the crisis).
When that happens, a material amount of liquidity will be removed from the system, driving asset prices down.
2. Understanding the Treasury General Account Balance
The Treasury General Account Balance, essentially the checking account of the US federal government, is a crucial component of global liquidity.
When this balance decreases, it signifies that the government is spending more, increasing liquidity in the economy.
The TGA has declined for the past few quarters, supporting global liquidity and risk assets.
We anticipate a significant increase in TGA in the coming months, which will drain liquidity from the private sector.
3. Inflation is running at 2-3 times the Federal Reserve’s price stability target.
Given current inflation rates, it doesn’t make sense for Secretary Yellen to support financial easing by flooding the market with T-bills.
Easing financial conditions would drive asset markets higher, only making inflation worse.
4. The Impact of the Inverted Yield Curve
An inverted yield curve occurs when short-term debt instruments (like T-bills) have a higher yield than long-term debt. It’s often seen as a predictor of an upcoming recession.
Because the Treasury needs to pay interest on issued debt, they are incentivized to lock in the lowest rates, which are currently notes maturing in the 3-10 year range.
This is another reason we believe Secretary Yellen is unlikely to flood the market with T-bills, supporting our view of lower asset prices in the quarters ahead.
5. Changes in Global Central Bank Policies
Global Central Banks also have massive implications for global liquidity and, therefore, asset markets.
We foresee another headwind for asset markets:
The two central banks responsible for the improvement in global liquidity the most over the past year, the People’s Bank of China (PBOC) and the Bank of Japan (BOJ), have been draining liquidity over the past quarter (on a trailing 3-month impulse basis).
The impulses take time to flow through financial markets, but we expect the actions of the PBOC and BOJ are likely to serve as a headwind for risk assets in short order.
6. Potential for a Rough Summer
We expect a shift in liquidity conditions from a very positive trailing six months to a more challenging period over the next two to four months.
The actions of the Fed, Treasury, and Foreign Central Banks over the next 1-2 quarters are not supportive of a positive liquidity environment.
Our advice to you is: if you are invested in risk assets, be careful.
That’s a wrap!
If you found this thread helpful:
1. Go to https://42macro.com/macro-bundle to unlock actionable, hedge-fund caliber investment insights
2. Have a great day!