Keep An Eye on Commercial Bank Liquidity Trends

July 23, 2014
By Knowledge Leaders Team in Uncategorized

An interesting development this year has been the increase in purchases of US Treasury bonds by commercial banks.  In the chart below, we show the year over year increase in the holding of US Treasury bonds by US commercial banks set against the interest rate on 10-year UST.  This goes some way in understanding the move lower in rates this year.


This does raise a cautionary note for equity investors.  Commercial banks appear to be front-running the taper by moving to contract the amount of excess reserves in the banking system to fund their increase in US Treasury bond holdings.  As an aside, with the 30-10 year US Treasury spread contracting as high yield spreads widen, it seems that commercial banks are preferring to take on duration risk rather than credit risk. Over the last five years changes in banking reserves have exerted a strong influence on momentum trends in the equity markets.  In the chart below we show the 3-month difference in commercial bank excess reserves (right scale, red line) vs. the percent of stocks in the MSCI World index above their 200-day moving average (left scale, blue line).  Equity investors should keep an eye on commercial bank liquidity trends.


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