The liquidity bonanza

The 'dark money' flows guiding the markets

From Tuomas Malinen’s Forecasting Newsletter.

A note. The U.S. Consumer Price Index (CPI) rose by 3.1% (Y-o-Y) in January, a pace quite a bit higher than what was expected (2.9%). Core inflation, excluding food and energy, rose by 3.9%, which was also clearly above expectations (3.7%). The ‘Supercore’ inflation, that is, index of service prices excluding energy, rose by a whopping 5.4%, which was the biggest jump in Supercore since September 2022. Moreover, the core inflation, excluding services and housing, rose 6.7% in a three-month annualized basis, which was a massive jump. It looks that the phase of decelerating inflation is over, for now, and uncertainty concerning the inflation and rate cut outlook reigns, like I warned.

Issues discussed:

• Money supply (liquidity) saw a massive increase in November and December, which carried the U.S. markets into a fierce rally.

• Central banks provided a major share of this, despite of their shrinking balance sheets.

• There’s a possibility of a cataclysmic draining of liquidity in March/April.

A little over year ago, I posed a question regarding global liquidity asking “Where to go when the road ends?” The question referred to the retreating flows of artificial liquidity from central banks, due to programs of quantitative tightening, and inquired are the central bankers really going to pull the ‘rug’ underneath the markets? Also around a year ago, data I discovered answered the question with a resounding “No, they are not.”

Now, if you have been wondering about the three-month rally in markets, wonder no more. It has been carried by very strong flow of liquidity, which has mostly come from the same “dark” source as before. Before we get into specifics of what has driven the market rally in the U.S., I’ll update the trends in global liquidity.

The issuance of USD denominated debt securities continued its descent during the first three quarters of past year. However, local and cross-border USD bank credit (loans) to non-financial institutions grew from Q1 through Q3, 2023. This is an interesting development to which, at least now, I have no definite explanation. However, the efforts of Beijing to resuscitate Chinese economy during 2023 is a likely source for the reinvigorated global bank lending. Thus, it can be just a ‘blip’ in a declining trend, like what occurred between Q3 2020 and Q4 2021 (the Corona stimulus). When we turn into money supply of leading nations, things get even more interesting.

I summon thee (liquidity)

In February past year, I discovered the massive role China plays in providing global liquidity. In July, I used the seasonality of the liquidity injections from China to forecast that the fall in the markets would be “choppy” with a risk of a collapse. Markets headed down from early August on, but they did not crash. In early November, like a strike from a “wand”, the trend turned and markets started their fierce rally. The reason why it was so fierce is depicted in these two figures.