A Global Dearth Of Liquidity

Year-on-year growth rates in M1 (black line) and M2 (red line) in China – historically these growth rates are remarkably slow.

Evidently, no serious reflation efforts are underway as of yet, although the PBoC has cut minimum reserve requirements several times this year and is frequently seen injecting short term liquidity to keep repo rates under control. Recently chatter about an imminent rate cut has become more insistent. Over the past few days it has intensified, as the rally in the yuan on the heels of the talks between Donald Trump and Xi Jinping was seen as giving the PBoC more leeway to ease.

So far, said rally was a one-day wonder and we are not sure whether a rate cut will actually do much to reverse the trend. Besides, as we always point out, the effects of the slowdown in money supply and credit growth have not fully played out yet – a sizable lag is to be expected. For example, by the time the full effects of the slowdown from 2014 to early 2015 were felt around the world, growth in China’s M1 had already reversed back up again and was rising steeply.

Conclusion

In summary we can say that although y/y money supply growth in the euro zone and Japan is still fairly strong for the moment, the trend is definitely no longer supportive. Not surprisingly, we have recently not only seen weakness in stock prices, but also fairly sharp breakouts in credit spreads, as positive arbitrage effects are beginning to dissipate.

Credit markets in particular were benefiting from the ECB’s corporate bond buying program. As we have pointed out in past articles on credit spreads, the fact that spreads in the euro area had begun to rise while US credit spreads were still trading close to their lows constituted a warning sign, as the former have been leading the latter for quite some time.

In short, the markets are facing a far more profound problem than just the question of whether the trade dispute can be resolved to everybody’s satisfaction, or whether a smooth Brexit can be achieved or whether the conflict over Italy’s budget will be settled amicably.

For some reason many people seem to completely ignore the Fed’s QT operation and the cutback in central bank support elsewhere, but this is precisely what one should focus on. As we have stressed for a long time, money supply growth is the most important fundamental datum for overvalued risk assets. Everything else is just decoration.

Footnote:

*In particular, the BoJ only counts only deposit money belonging to members of the private non-financial sectors as part of M1 – which means that non-bank financial intermediaries are excluded (Frank Shostak’s money AMS measure for Japan exhibits considerably greater volatility – unfortunately we don’t have the resources and/or time required to obtain the data he has access to).

Charts by ECB, Michael Pollaro, the Daily Shot (WSJ), St. Louis Fed, Bloomberg

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