"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.


Sudden Debt Cordeezy Sat, 06/17/2017 - 13:46 Permalink

credit is slow already a few months right now.I know quite a few who had their project funding frozen by the banks. And that means when this goes global that a serious amount of contractors and linked companies are going to get in a serious amount of crap if this continues through the summer. There's also something happening in the insurrance bizz right now just like in 2007. And back in the day, those where the guys who set the first big crisis in motion.

In reply to by Cordeezy

ebworthen Sat, 06/17/2017 - 13:25 Permalink

FED is raising rates and saying they are going to start selling all the crap they shoveled up to bail out Wall Street and the Elites.Time to shake down Mom and Pop again, raid the Pension funds, rake the lemmings chips off the green felt.

philipat I am Jobe Sat, 06/17/2017 - 19:49 Permalink

Yes, half of the Fed's Balance Sheet comprises all the toxic mortgage shit that The Fed magnanimously purchased (at full face value) from the Banks as part of the rescue bail-outs in 2008. At present, this toxic shit actually has a "market" value as a result of the bubbles that The Fed has created. Yellen must be having wet dreams about being able to unload all this toxic shit back onto the taxpayer (a/k/a a double screwing) via pension funds, ETF's and institutions. Fool me once, same on you....To quote many of the pundits, "it's all about confidence" and Yellen is pushing her luck IMHO. That same "confidence is also just as valid as in "confidence trick" or CON for short!Unfortunately for The Fed, I suspect that the buubles will burst before the FEd has to reverse back into QE mode OR the financial system collapses and the IMF has to rescue all the CB's with massive SDR printing?

In reply to by I am Jobe

Sudden Debt ebworthen Sat, 06/17/2017 - 13:48 Permalink

It's their last quarter where they can stock up on some dry powder.If shit gets real, all they've got is lowering rates.And now they can't print to much money anymore because there's not much to buy anymore.If they print now, they'll have to throw that money into the real economy and that means a 50% inflation in the first 2 years when they do that. 

In reply to by ebworthen

choco bunny Sat, 06/17/2017 - 13:33 Permalink

Well of course the next leg is clearly lower.  And now we are at six years late and they are still saying that.  the one analyst and editor for markets in US that is actually showing profitable analysis and trades is Shepwave.  It is obvious.  they do show some of their past trades on their facebook pages   https://www.facebook.com/166578775325/photos/a.10153488951800326.1073741827.166578775325/10154415124400326/?type=3&theater

NoWayJose Sat, 06/17/2017 - 13:36 Permalink

Every time "Liquidity" has been mentioned as "Drying Up" for the last 8 years, some Central Bank somewhere rides to the rescue. Loans do not matter - businesses expand by selling high priced stock - and Central Banks are there to buy it. "Assets" to purchase used to mean bonds - now it includes stocks, ETFs, mortgage backed securities, and Lemonade stands.

And Yellen never promised to 'sell' anything - but rather to 'buy less' with the interest she is getting on the bonds she already holds.

gold rubeberg NoWayJose Sat, 06/17/2017 - 13:53 Permalink

The Fed would effectively have done net sales if it were to reach the lower balance sheet target it's talking about. That said, the long term program it's laid out is absurd ... there's no way it can tell us what it's going to do months and years in advance and simultaneously respond to data as it emerges. There is a fundamental conflict between its efforts to be "transparent" (read "predictable") and to be "data dependent".

So out the window with any illusion of credibility. It would actually have to stop talking out of both sides of its mouth and start telling the truth for that.

Unless it started right away, it's doubtful whether it will get very far with any of its grand QT plan anyway. The stock market is likely to crack and they will chicken out in a New York Fed minute.

In reply to by NoWayJose

Quinvarius Sat, 06/17/2017 - 13:51 Permalink

All the money they printed went into the financial markets because they gave it all to finanical institutions and allowed them to operate in the markets.  It needs to come out.  They need to make loans profitable for banks and markets not profitable for banks.  Loans are not profitable due to interest rate manipulation.  Markets are profitable and bubbled up.  The conditions that festered under Obama need to be reversed.

Youri Carma Sat, 06/17/2017 - 14:04 Permalink

What I see now is tiny FED rate hikes (to keep the dollar from falling off a cliff) with printing presses still on around the globe. But deflation (softer inflation) is clearly here with loan growth stalling and lower oil prices and global liquidity collapsing. So where does this leave us? FED's history suggests more of the same so no more rate hikes and more printing allegedly to stop the deflationary forces while in fact FED's policy is the main deflationary force.Tapering, printing or not tapering, printing doesn't matter anymore or in other words, the FED has lost control and deflation will run it's course no matter what. This much has been clear now from 2008 on in the real economy but will manifest itself now in the rigged financial Micky Mouse economy which will catch up to the real world. Or in the famous words of Walt Disney: "It's a deflationary world after all." ;)Also see:Weekend Reading: Charged With Obstruction http://www.zerohedge.com/news/2017-06-16/weekend-reading-charged-obstru…

TGF Texas Sat, 06/17/2017 - 14:14 Permalink

America will always be fine, until we loose reserve currency status, which is proped by petro-dollar.  Right now everyone elses Federal Fiat printing machines, are running full tilt, i would say that the printing is going to get them in trouble, but then I compare everything to japan, and go "shit" there deception is still going, everyone else has a long way to go. Ow, and the next major bail out/in/up/straight in the tax payer anus, is going to be the liberal states. Mark my words, the Rino's may stand their ground on this insanity for a little while, because they are forced to. Eventually, the Dem's will get back in power, or will get enough Rino's to join them. When there are no consequences for bad behavior, then the only loser is the one not exhibitng the bad behavior. "Red states, should just go full fucking retard on spending. I.E build walls around the entire state, and buy fucking piles of gold and guns. 

Harry Lightning Sat, 06/17/2017 - 15:21 Permalink

The models presented offer the equation that economic output momentum is a function of liquidity changes in the economy, liquidity being created by either central bank reserve formation or commercial loans. What is not explained is how economic output momentum responds when the participants in an economy choose to invest or save relative, relative the performance that occurs due to new consumption. If considerably larger amounts of new reserve creation winds up being saved by its holders instead of being lent, don't we create a relief mechanism whereby consumption becomes a zero sum sister to investment ? If holders of reserves decide to cash in some portion of their investment holdings in order to increase consumption, shouldn't that stimulate economic output momentum ? In the abstract, isn't that what happened in the six months between September 2008 and March of 2009 ? If these questions are answered affirmatively, we then can confirm what many have claimed is the predictive value of the stock market, in that it has a good track record of predicting economic performance six months in advance. If the Deutsche Bank model is correct, we should expect to see liquidity flow out of investment markets and into consumption soon.The interesting question is how to determine when changes in reserve growth affect the process. How does excess reserve liquidity that has been placed in investment markets affect the economic output momentum ? To what degree does growth in reserves offset weakening loan creation in terms of the effect on economic output momentum ? There should be some function to describe the effect on economic output momentum from past reserve creation that wound up in investment rather than consumption. For example, if reserve creation increased for the last year by 20%, and all of it wound up being committed to investment vehicles, what happens now if the reserve creation falls to a slightly negative decline of 5% ? Do we average the last two years and see reserve creation growing by 7.5% or does the immediate change in reserve creation alone affect the economic output momentum, even if past reserves created start flowing into the consumptive economy ? I don't think many people will argue against the premise that much of the reserve creation of the last several years has wound up in investment rather than consumption. Hence, negative bond yields and overpriced equity markets. Loan growth is now near zero because with loan rates near zero everyone who could borrow has borrowed. If reserve growth and loan growth both shrink to zero because no one needs any more money, why would that be recessionary as long as the investment markets continue to be the store of the reserve liquidity that was created by not yet metabolized ? Think about the fat storage of the human body...that extra hot dog and beer at last week's ballgame will be burned at a later date, because for now their calories have been devoted to "investment" as opposed to consumption. (Think about that if you have a belly...you are a consummate "investor" !) Which leads us to recognize that changes in reserves or loans cannot by themselves predict economic activity going forward. The entire equation becomes a function of how the excess liquidity of past years has been utilized. Presently, there is a huge amount of excess liquidity, trillions of dollars, sitting in overpriced bonds and equities. When the time comes that economic participants choose to start consuming again, there will be more than adequate fuel to power that engine. The real factor that will determine where any economy goes is what presently holds back new business formation. It very well could be that in the US, economic growth is a victim of its own success. The nation is at full employment, consumers are comfortable with their present levels of consumption, and there is no need to borrow money. The economy can persist at these levels of very high consumption for quite some time, and even though the economists will contend that economic growth has stalled, it will not be a weak economy.The bottom line is that measuring the strength of an economy solely by whether it is growing or shrinking is a very limited picture that in the present situation in the States does not adequately define the true situation. The best that I think can be said about the Deutsche Bank work is that some of the economy's fat stores need to be transferred from investment to consumption, and that is what likely will happen soon.

mo mule Sat, 06/17/2017 - 16:34 Permalink

Insurance Companies are about to go out of business.  There hasn't been any money to be made on the spread. They have suffered thru 8 years of this and spent their reserves trying to stay afloat.  With rates on the 10 yr below 2% they can't pay the insured and have anything left for them.  The jig is up.......Wall Street and the CB has killed main street.  So it doesn't matter, big bankruptcies are on the horizon.  The summer of the crash is in front of us now.You can only push so much money into the system with low interest rates. Cheap money will not drive profits higher and higher on it's own. The day of pay back is here!A 30% to  50% crash should happen prior to this Nov......A hugh reset is coming, it has to, the FED has sucked all the monies out of main street. They'll be lucky if their not hung on the lamp posts by the time this is over.  The John Law saga does not rule, and the people are coming for you bankers.....!!!!!!! 

Snaffew Sat, 06/17/2017 - 19:35 Permalink

non stop deplorable economic news both nationally and globally yet they still managed to run the markets green on Friday.  I think I have been thoroughly conditioned to anticipate the futures to be strongly up for Monday's market open and the game to go on---but I still hold out the tiniest bit of hope for a black Monday to finally appear.  I'm so tired of every minute selloff in the markets being bid right back up by the PPT that it sickens me each and every time.  Will this game ever change? Something has to break soon, everyone is on board thinking this time is different.  This herd mentality has swelled to an epic bubble in and of itself---eventually that has to pop along with the markets.  One can dream---

vladiki Sat, 06/17/2017 - 21:51 Permalink

Problem is - the system is a plane that needs not just to maintain speed to stay up ('quantity of debt') but needs to keep accelerating to stay up ('steadily increasing debt'). The system was going down in 2007; Central Bank' ZIRP and QE were boosters that kept it accelerating and kept it up. Now, they're spent. There's much talk of the inevitable next step being monetisation. That would just be the last can-kick, and involve the deliberate/accidental destruction of fiat money and the financial system. Best they don't go there, but they might. Putting off the unpleasant is a powerful human reflex we have to learn to override.

A great pity that in 2007 Bernanake tried to outsmart his predecessors of the 30's and didn't just (more intelligently) 'purge the rottenness from the system'. It'll have to happen. The longer we leave it the more traumatic it will be. Considerable asset 'wealth' will evaporate. Debt will be crushing and perhaps need targeted jubilee. It's when, not if.