A Dramatic Change in the Liquidity EnvironmentDecember 02, 2014
By Uncategorized in
For the last six years of quantitative easing, commercial bank non-borrowed reserves have been a good proxy for liquidity. These reserves have grown from under $50 billion in 2008 to $2.8 trillion at the peak a few months ago.
In the last few months as QE has ended in the US, however, these reserves have tumbled some $283 billion. This drop in reserves telegraphs an increase in the federal funds rate. Based on the relationship in the chart below, it looks fed funds are likely to rise to 25bps in the near future, perhaps priming the pump for the first rate increase next year.
This drop in liquidity is probably also a good explanatory variable to the drop in oil prices and in turn energy stocks.
Given the relationship between the broad equity markets and non-borrowed reserves, the recent divergence between stock prices and reserves is particularly alarming.
Momentum trends have particularly diverged from liquidity trends lately.
Its been a while since investors have had to pay much attention to liquidity trends with QE continuously injecting liquidity for the last five years. With QE over, it may be time for investors to turn their attention back to these trends because there has been a dramatic change in the liquidity environment, with potentially big consequences for asset prices.