Market Liquidity Conditions Are Still Loose As A Goose

Via Global Macro Monitor,

Since the Fed began raising interest rates in December 2015,  financial market liquidity conditions have loosened considerably.   Recall our post,  Orwellian Monetary Policy,  which we wrote in May.

“Tightening is Easing”


Since U.S. monetary policy began tightening in December 2015, the Fed has added liquidity to the financial system through interest payments to banks on excess reserves and has reduced its surplus to the Treasury adding to the fiscal deficit.  Thus the financial system has had an effective injection of central bank liquidity and a fiscal expansion during a period of monetary tighenting. – Global Macro Monitor

The current Fed policy effectively injects liquidity into the financial system through raising the IOER rate — printing money to make interest payments on reserves banks hold on deposit at the Fed.   This compares to the traditional monetary where the Fed drains reserves from the financial system to drive the Fed Funds rate higher.   We are years off to getting back to traditional monetary policy.  Maybe not in our lifetime.

Performance of Stocks, Bonds, and Emerging Markets 

No wonder then markets are going bonkers.   Take a look at the performance of a select list of indicators since the Fed began raising interest rates.

The S&P500 is at an all-time high, up over 20 percent since the Fed shifted to a tightening regime;  the 10-year Treasury yield is only up 5 bps;  the 10 minus 2’s yield curve is 32 bps flatter;  the dollar index is down -3.12 percent (we expect a big rally if any healthcare bill passes) ; the VIX is down over 50 percent and closing in on its December 22, 1993, all-time closing low of 9.31 and will probably take out its intraday all-time low of 8.89, set on December 27, 1993, sometime very soon.   The VIX has only traded below 9 one time.  See here for how the two VIX indices were concatenated or spliced tin 2003, merging the OEX VIX (VXO) with the SP500 VIX.

Emerging Markets Hot, Hot, Hot!

More impressive is the performance of the emerging markets.  Wasn’t Fed tightenings supposed to, and have historically,  wreaked  havoc on EM capital flows?   The JP Morgan EM Bond ETF (EMB) is up over 16 percent and the emerging market stock ETF (EEM) is up almost 40 percent!   The Mexican peso has rallied 20 percent since January 19, which is mainly due to the Trump slump in the polls.   Stunning, nonetheless.

 “John Bull can stand many things, but he cannot stand  2.0 , [-1.5 or 1.25]  percent”  – Bagehot

No great flop in commodities either with the CRB essentially flat since the Fed began raising interest rates.

Fed Has Lost Control 

The Fed has once again lost control of a big part of monetary policy.   Its ability to influence the risk taking incentives of the markets (see chart below).  This is not the first time,  but it has been exasperated by the structure of the new monetary policy,  of which we spoke about earlier.

No judgement, whatsoever,  on the policy makers.   They saved the system and kept many of us from living under freeways and have a very difficult job.   They now find themselves in a real dilemma, however,  with another major global asset bubble on their hands.

We believe this is why the Fed has quickened its pace to start shrinking their balance sheet.   Rather than being  forced to overshoot interest rates, which could adversely affect the economy,  the Fed will start draining reserves through balance sheet reduction hoping to introduce some risk aversion and sense back into the giddy global markets.

Real Interest Rates

Finally take a look at real interest rates.   The current level of the 10-year real Treasury yield,  calculated as the nominal yield less the 1-year lagged PCE deflator, is only at the 19th percentile on a monthly basis going back to the early 1960’s.   Our sense is rates are going to have to move much higher (200-300 bps)  and quantitative tightening is going to take some time to really break these markets and burst the global asset bubbles.

Asset bubbles don’t pop very easy,  until they do.

In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”   – Rudiger Dornbusch

The first derivative trade, that is selling when the direction of policy changes,  is not going to cut it this time around.   Global interest rates are just too low and the flood of central bank liquidity is too high.

The bears are much too loud and adamant and the buy the dipper Algos are in control.   Until they aren’t.


Nevertheless,  assets are exteremly expensive,  monetary policy is moving in the wrong direction and the market is very vulnerable to a sharp selloff given a Black Swan event,  which we increasingly think may be some sort of geopolitical shock or a  humumgous populist backlash, for example,  as the wealth gap continues to widen.

Billionaire preppers.  Did you ever think you see the day?

…survivalism has expanded to more affluent quarters, taking root in Silicon Valley and New York City, among technology executives, hedge-fund managers, and others in their economic cohort. – New Yorker,  Jan 30, 2017

We are thinking October for a sigfinicant correction as the Fed should be on their way to getting smaller and China’s Party Congess should have concluded raising the risk of a market or policy shock in the Middle Kingdom.   But everyone is looking for the same.

It is tough and sometimes a career killer to watch a runaway market waiting for Godot  a market correction that doesn’t show up.   That keeps a “night sweat bid” in the market.   You know,  when your under allocated and the market keeps ramping and you awake in the middle of  the night in a cold sweat.    Night sweats and migraines.   We don’t miss those days.

Finally,  the path of least of resisitance seems to be  higher for risk assets, but as Ray Dalio says,

  … keep dancing but closer to the exit and with a sharp eye on the tea leaves. – Ray Dalio


eclectic syncretist blueyefinity@y… (not verified) Sun, 07/16/2017 - 17:16 Permalink

I don't know how much these guys get paid to write these analyses, but when a stock like MSFT has a 10 day average daily turnover of 0.25% of the float (and steadily declining), I would not characterize that as being a highly liquid situation. Many similar situations are observable. GOOG is even worse. In summary, I would say that when the time comes to sell one might just find the exits suddenly blocked with bodies. Whether my clients wanted to hear it or not I would recommend being mostly flat right about now. When the last of the people who actually have pensions (think baby boomers) start drawing down their savings the effects on the market could be quite substantial absent a huge fed intervention that would (as always) result in a severe devaluation of the dollar.

In reply to by blueyefinity@y… (not verified)

Soul Glow GooseShtepping Moron Sun, 07/16/2017 - 14:29 Permalink

The market is bigger than the boomers' SS funds and their tiny 401(k)s.  The market will be determined by leveraged debt vs actual production.  What many can't figure out is why the shit system is still working.  It's because debt is still able to be leveraged by the banks and people will continue to put the next 30 years of their income into a promise to pay a bank interest to do so.  The system is functioning becausse everybody is fucking retarded and will work for pennies on the dollar while leveraging what purchasing power they do have to have a slice of the "American Dream".  And people chasing the American Dream, due to the fact that they are using leveraged debt to do it, is not equaling a large increase in production. So instead of asking the simple question, "How is this system still functioning?" people should be asking "Does it matter that everyone is fucking retarded?"  The answer is yes, yes it matters that everyone is fucking retarded.  Sure, poor people are retarded, that 's why they are poor, but what isn't often said is that rich people are equally retarded.  Rich people live so high on the horse they can't even imagine what their feet on the ground feels like.  There was a brief moment where they almost had to stable their horses and walk but then the banks made the politicians do the bailouts.  They were able to keep riding.But this was a temporary solution to the problem.  What is the problem though, that is what we should asking ourselves.  Is it that the dollar has no intrinsic value? Yes, but it goes deeper.  Is it that people do not own their houses until the bank is paid in full and even after the government will tax the shit out of you?  Yes but deeper.  Is it that banks leverage fake assets to buy other assets to buy other assets and so on?  Yes rehypothication is real and is an illusion but it goes deeper.  The real problem is that everyone is fucking retarded and can not fully understand finance and economics let alone tie their own fucking shoes and speak coherantly at the same time.So why is this a problem?  Can't we just print money ad infinum, buy ice cream on credit, bitch about the cable bill, and lease cars we shouldn't be able to afford?  No.  No we can't.  The reason is simple.  Reality exists.  Reality is not an abstraction like credit, like complaining, like debt.  Reality is an absolute.  It is the sun, the moon, the stars.  It is a storm, a drought.  It is when ice cream melts before it is eaten.  It is when someone realises cable is not a right and if someone doesn't pay the bill it will be turned off, it is when someone loses their job and gives up their lease.  It is when the debt leveraged becomes higher than the input cost of funding the dollar ponzi scheme thus exceeding the value of the dollar itself.  Then the magic show, the illusion, the fantasy we have all been living, vanishes in an instant.  And when that happens, POOF!  It's all gone."Martha is polishing the brass on the titanic, it's all going down man!"

In reply to by GooseShtepping Moron

Fartboxbuffet (not verified) Sun, 07/16/2017 - 13:19 Permalink

As loose as obamas rectum after a night on the bath house circuit in hood rat land

Soul Glow Sun, 07/16/2017 - 13:22 Permalink

There will be a correction this fall in equity, just as there has been a recent correction in crypto-currency and before it in precious metals.  The equity correction will mirror the other two, it will be about 15% before the President's Working Group on Financial Market's steps in.  After all, Trump's ego will not let equity fall his first year in office and he will run up debt to preserve the gains he has touted.After the correction there will be a bound of 7% or so.  The Fed will then be given the "opportunity" or rather the excuse to curb their rate hikes and stocks will flatline.  Yellen will leave and Cohn will replace her.  If the foxes were not already in charge of the hen house (they were) then with Goldman's Cohn in the big boy chair they will take full control.  One thing we have learned is they like to crash markets so to BTFD - the big dip, not some little boy dip either.  Cohn will put in place the conditions to have a crash happen in between late 2018 - 2019 and the collapse will usher in the "One World Currency" the zionist cabal has wanted for decades.There are a few more years before this happens though, as Trump does not want to be remembered for this happening under his watch.  The problem though is unbeknownst to him by putting Goldman in charge he has  put a werewolf in charge of his little hen house.  Trump is to be blamed not because he wanted the New WOrld Order to come to fruition - he doesn't and he is honest when he says "America First" - but that he trusted the wrong people to drain the swamp because asking New York City boys to drain the swamp is like asking them to not invite hookers out to the Hamptons.So keep trading bitcoin and keep stacking the shiny.  You have another year or two before the dollar collapses and there is no way to measure asset prices.  This is when the SDR makes it's way to the front of the line.  Not only will it be "backed with gold" to quote Darth Soros but it will likely be that central banks begin to use their own crypto currency to link the SDR to regional spending.  I'm surprised I haven't seen crypto users figure this out yet, but this is the point of ethereum.  The banks are beta testing cryptos while you day trade it.

my new username Sun, 07/16/2017 - 13:23 Permalink

"but it has been exasperated by the structure of the new monetary policy" I think he means exacerbated, but it may well be the Ghost of Steve Jobs that lurks in iOS and OSX, craftily rewording one's writings ad hoc and willy nilly.

Bluntly Put Sun, 07/16/2017 - 13:27 Permalink

"No judgement, whatsoever, on the policy makers. They saved the system and kept many of us from living under freeways and have a very difficult job. They now find themselves in a real dilemma, however, with another major global asset bubble on their hands."

How does enabling and continuing the problem "save" us? They are the problem.

buzzsaw99 Sun, 07/16/2017 - 13:46 Permalink

No judgement, whatsoever,  on the policy makers.   They saved the system and kept many of us from living under freeways and have a very difficult job... The author is no ZHer.  Fuck that, let it burn asshole.

TrainReck Sun, 07/16/2017 - 16:28 Permalink

Cash will be King in the very near future. As much as I like and have invested in Silver, it's for the longer haul like 8-10 years. Deflation is going to set in like a mother fucker and those with greenbacks will be the ones that survive & prosper with the next shitstorm about to hit. Deflation is what happens when the macroeconomic financial system takes a very big dump like it did in 2008. My fucking house went from being worth $735k in 2006 to $275k in 2009. That's deflation when a shitstorm hits. Next time soon, there is no stopping or delaying it from permanently resetting the value of everyone's material possessions. The value of something is only what others or someone is willing to pay for it. When those that have hung onto their under water homes start panicking, you'll start to see a rush of foreclosed inventory and fewer buyers. It'll be 2009 x 10.

ElTerco TrainReck Sun, 07/16/2017 - 16:57 Permalink

T-bills may be "safer" than holding physical cash. Many countries have made their largest currency bills worthless (yes, worthless) when the Shit Hits The Fan. Actually they sometimes give a very short time frame for exchange, but there is often a cap on the amount exchanged. For examples, look at Russia in the early 1990's and India just recently. Very small denominations are usually allowed to keep circulating as-is.

In reply to by TrainReck