For those of us who track Global Liquidity, 2016 does not look to be a happy year: markets seem set to face the chill headwinds from the regular 8-10 year down cycle in capital flows that blew fiercely in 2008...and before that in 1998, 1990, 1981 and 1974, too. This looks and smells like another bear market.
Three numbers in our just released December 2015 data portend more trouble ahead:
First, China suffered further whopping financial outflows totally $$146 billion and making $$0.8 trillion for 2015 as a whole.
Second, a record $$37 billion fled Russia in the month. While China is deflating, Russia is inflating and surely faces upcoming social and financial challenges as high street prices jump?
Third, and of deeper concern, the pace of corporate cash flows heading into the US wholesale markets slowed significantly. Given the Fed's recent rate hike, this matters a lot.
Adding these three factors together spells out another monthly decline for our Index of Global Liquidity conditions to 41.8 ( normal range 0-100). These Global Liquidity Indexes lead world markets and business activity by up to a year. They have been subpar during 2015 but only turned negative for the US a few months ago.
The US liquidity situation is important because we all live in a dollarized world economy, where the supply of funding is jointly controlled by the Fed and wholesale money markets. Focus here on two key structural changes:
First, since the 2008 crisis, US industrial corporations have boosted their profits and cashflow through aggressive cost control, but at the same time shelled out little on new capital investment, preferring instead to deposit Treasury funds in the wholesale markets. Ironically, US banks saddled by new Basel 111 controls, actually don't want this money.
Second, anxious to control these newly cash rich wholesale markets, the authorities are incentivizing prime money market funds to convert into Government-only funds, so allowing them to deal directly with the Fed through lucrative reverse repo transactions. Lured by higher risk-free returns, these money market funds will compete head on for banks' retail deposits and switch their own deposits into the Fed. The recent step up into Fed reverse repo sales and resulting squeeze on bank credit and the commercial paper markets coincides with the recent down turn in corporate cash flow. it belies a so called 'small' impact from the 25bp upward move in Fed funds: maybe the latest 35% annualized drop in US monetary base gives us a better heads up that US liquidity is skidding.
With US dollar credit getting much tighter it makes sense that the profligate periphery gets hit first. Think of the cited Chinese and Russian capital outflows, alongside stresses in the domestic corporate credit market in these terms. These two countries deserve to grab the headlines, but across the Emerging world dollars are heading back to their New York centers. Even excluding China, December witnessed another huge $$104 billion net outflow from these markets. All are hooked on dollars. Contrary to the musings of many pundits, it is not prudent Chinese savers, for example, that have been financing rapacious American consumers, but rather US banks that are still directly and indirectly funding dept-swamped Chinese industries. After creating the world's biggest ever asset bubble involving a 12-fold rise in her asset economy since 2000, China now faces the equivalent asset bust as dollars are sucked out. Hence the now obvious pressure on Chinese yuan exchange rate and China's reserves as the People's bank wrestles the markets.
The gathering liquidity storm is the main reason behind plunging World commodity prices. The turmoil in the oil market largely reflects a lack of Saudi control, not their much heralded deliberate actions to raise output and so discipline wayward fringe producers. In the latter case surely $40 or $50 oil would be enough to do the trick? In fact, Saudi too, is suffering loses with ££11 billion net capital quitting in December. Significant maybe, but not as catastrophic as the far larger holes punched in Chinese and Russian finances.
What the fragile market oil warns us, is that with no one in control, prices could be highly volatile. Crude could catapult higher from a demand shock if China decides to ease policy, or Russia engineers a supply disruption. There is a lot at stake for Beijing and Moscow. The moral is never to confront a bear of any type... especially a wounded Russian one.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.