“The Next Leg Is Clearly Lower” – Global Excess Liquidity Collapses
First it was Citi’s Hans Lorenzen warning about the threat to growth and global risk assets as a result of the upcoming slowdown in global central bank balance sheet growth. Then, yesterday, it was Matt King’s turn to caution that “the Fed’s hawkishness this week adds to the likelihood that in markets a significant un-balancing (or perhaps that should be re-balancing?) is coming.“
That said, with both the ECB and BOJ injecting hundreds of billions each month – even as they are set to run ouf of “haven assets” in the coming year, there is still time before the global central bank balance sheet “tipping point” is reached and assets roll over…
… although last week we flagged a more immediate problem for credit, and thus liquidity, in the US when we showed that even though the US is reportedly growing at a comfortable rate (the Atlanta Fed’s nowcast has Q2 GDP rising 2.9%) loan growth in the US is just weeks away from contracting for the first time since the financial crisis. Such inversions have traditionally taken place when the US economy was already in, or about to enter a recession.
As a reminder, whether endogenous or exogenous, liquidity has to be created somehow – either though loan creation by commercial banks, or reserve creation by central banks – for growth to persist and to keep asset prices elevated. The moment the process slows down, halts or reverts, is when “equilibrium phase shifts”, i.e., recessions, depressions, or market crashes occur (more on that in a subsequent topic).
So continuing these observations, overnight it was Deutsche Bank’s turn to warn about the deterioration in credit creation, or as DB’s Dominik Konstam calls it, “excess liquidity” (a term first introduced by JPM back in 2013) which as he writes “continues to weaken in the US” and as a result “output momentum” or simply stated “growth” is still weakening. In an analysis conducted by the DB credit strategist, summarized by the six charts at the bottom, he finds evidence of “further softening in PMI data” and notes that “we continue to view softer inflation as a preferable remedy for weak excess liquidity rather than deeper declines in output growth.” Or tumbling stock prices, perhaps? He summarizes this mix “in the spirit of a “falling price boom” where weaker inflation supports real growth as purchasing power is restored”, although at the same time this transitory deflationary impulse leads to the threat of an even greater build up of unsustainable debt, as has been the case for the past 8 years.
Here is Konstam’s explanation on what the slowdown in “excess liquidity” means for the world economy and markets:
We have updated our yield momentum measure to highlight that as output momentum rolls over, even if yields remain unchanged here, it will still take a few months to see yield momentum falling back to zero with the very near term suggesting yield momentum is too high. We see this as consistent with our bias that at best yields remain broadly unchanged but at worse, near term, there is downside potential. This relies on the analysis that shows output momentum turning points are closely tied to shifts in yield momentum (here we are using 5y5y G3 yields versus a year ago). In sum the latest data for our excess liquidity framework does not lead us to change our view that yields can quite easily trade below 2 percent in 10s for the US and closer to 2 ½ percent for 5y5y OIS.
Finally, showing the critical role of “excess liquidity”, in this context through loan creation (or the lack thereof), Deutsche Bank presents the following six charts, showing their impact on everything from global momentum, to inflation, to sentiment surveys such as PMIs. What is clear is the the next leg in both regional and global economies is clearly lower.