Understanding Global Liquidity
Global liquidity, the aggregate of cash and credit flowing in financial markets, has been an economic lifeline in these tumultuous times. After a brief decline last year, it appears to be expanding once again, giving a fresh boost to stocks and business operations worldwide.
Quantitative Easing is Back
Remember the buzzword of the past few years, central bank quantitative tightening? The idea was to reduce the extensive stimulus programs which supported markets and economies over the last few years. Well, it appears that this phase has now come to an end.
Experts estimate that the liquidity cycle bottomed out in October 2022, and they anticipate a rising trend in the coming years. For investors, this means a sustained boost from global liquidity, potentially benefiting businesses while posing challenges for bond investors.
Governments Have a Lot of Debt
Taking lessons from Britain’s gilt sell-off last autumn, future hurdles for sovereign debt markets look increasingly likely. This situation poses tough decisions for policymakers and investors alike.
Notably, central banks, led by the US Federal Reserve, have recently pumped considerable amounts of cash into money markets to stabilize banks. Soon, however, these banks may need to extend their support to debt-ridden governments.
In essence, both markets and governments increasingly depend on central bank liquidity for their financial and fiscal stability. In a debt-laden world like ours, large central bank balance sheets are not just a luxury, they’re a necessity.
All of which means – quantitative easing is making a comeback. Bad news for bonds, potentially good news for other things.
Despite the expected decrease in the US Fed’s balance sheet size, the reality has been far from definitive. Decreases in direct bond purchases have been compensated by other liquidity-generating initiatives, things like short-term lending to commercial banks.
Moreover, the US Treasury is contemplating buybacks to enhance bond market liquidity and considering reducing the average duration of Treasuries available for private investors.
Looking forward, the pressure on public finances in advanced economies is expected to intensify as defense policies and aging populations increase compulsory spending.
Amid these circumstances, the US government will need to sell an average of $2tn of Treasuries each year over the next decade, with the Congressional Budget Office estimating Fed holdings of US Treasuries to increase to $7.5tn by 2033.
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