Collapsing Dollar Liquidity Sends Dire Signal For Stocks

With the ECB today confirming that its bond purchase program will end in less than three weeks, it is worth reminding readers that the world is now crossing that critical threshold where the consolidated global central bank balance sheet is shifting from a source of liquidity to a drain on the global (and fungible) monetary system. And as the chart below shows, every single time the total change in net central bank assets has dipped into the red, it lasted only briefly before some financial crisis typically ensued, forcing central banks to resume liquidity injections to maintain market stability.

Yet while much of the investing public appears to have forgotten about the danger from balance sheet shrinkage, instead focusing on such interim distractions as trade war, peak earnings or rising rates, it is only a matter of time before the need for continued "flow" (not "stock)" of liquidity manifests itself in sharply lower asset prices.

Confirming this, is a new note by Nedbank, whose analysts Neels Heyneke and Mehul Daya warn that "equity markets are vulnerable" and caution that "it is time for central banks or governments to step up to the plate to help these markets" reminding readers that "in 2008, the Fed underestimated the size of the shadow-banking system, and the rest is history."

To underscore this point, the analyst duo shows the following key chart which makes it unambiguously clear that there is a strong relationship between the change in global USD-liquidity (in the form of M1) and the performance of the global stock market, where liquidity leads the stock market by an average of eight months.

And since the rate of change in liquidity is now the lowest it has been since the financial crisis, absent a fresh boost to global $-liquidity, Nedbank expects this relationship to hold and "as a result the risk of further downside potential for stock markets across the world remains intact."

One place where the shortage of liquidity is already manifesting itself, Nedbank claims, is in the rising spread of USD-denominated Emerging Market corporate debt, where the spread is close to a breakout level. To Nedbank,"this is the "canary in a coal mine for risk assets."


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