Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Financial Markets Liquidity Bubble Religion

Stock-Markets / Liquidity Bubble Nov 25, 2009 - 02:35 PM GMT

By: Brady_Willett

Stock-Markets

Best Financial Markets Analysis ArticleThe dreaded “L” word – liquidity – has once again become the word to explain every major movement in every major asset class. Don’t understand why equities are outpacing the fundamentals – liquidity!  Can’t grasp why crude oil is up even though the demand outlook remains exceptionally weak – liquidity! Baffled by low or negative U.S. bond rates, the surging price of gold, and the booming Chinese real estate market - liquidity, liquidity, liquidity!



While it easy to conclude that ‘excess liquidity’ has played a key role in pumping up many asset classes, it is nonetheless difficult to quantify exactly what liquidity is. To be sure, there is no strict definition of liquidity and models are either in their infancy or nonexistent1.  On this front liquidity theories are somewhat faith driven; they neatly explain, without actually explaining, disconnects between the market fundamentals and market prices.

This is not to suggest that ‘liquidity’ – however you choose to define it – does not influence asset prices. On the contrary, given that there has historically been a distinct relationship between interest rates and borrowing, the same logic holds that there must be a liaison between interest rates and investing.  After all, much of the ‘investing’ done in today’s world is done with borrowed money.

With this mind, one of the more traditional indicators of the availability of ‘liquidity’ is the yield curve.  The general theory holds that when the curve is steep there is a greater incentive for borrowing/investing and when the curve is inverted borrowing/investing tend to slow down (an inverted yield curve almost always presages recession). One of the more popular talking points of the yield curve is the gap between the 2 and 10-year Treasury bond yields. This gap currently stands at 2.59 bps, or more than 3-times wider than the historical norm of the last 3-decades and near all-time highs. The basic idea here is that it currently pays very well to borrow short and go long.


Along with all of the liquidity speculations making the rounds, another related theme is the U.S. dollar carry trade.  The story here that market participants are borrowing U.S. dollar’s at almost zero percent to buy other higher yielding assets. A similar carry trade was previously seen when investor’s borrowed Yen at near-zero interest rates, sold yen for dollars, and then purchased U.S. government bonds yielding considerably higher than 0%.  However, where the Yen carry funneled capital primarily into the ‘safest’ and most liquidity market in the world in U.S. Treasury bonds, the dollar is reportedly being carried across numerous currencies and asset classes.

From Excessive Liquidity To Liquidation

Even as central banks adopted increasingly easy policies in 2008 nearly all asset classes declined.  The lesson from this experience was that ‘liquidity’ has a formidable foe in asset price destruction, and that no amount of liquidity can create rising asset prices if those charged with investing capital elect not to invest. 

In 2009 central banks have been wildly successful in enticing investors to take on more risk.  And while many have already started to warn that this rush to risk across nearly all asset classes is cause for alarm, some are encouraged by the boom:

“We have been very fortunate that the stock markets moved back” and are “re-liquifying the whole process”. Alan Greenspan

The ‘re-liquifying’ process Mr. Greenspan refers to is that of rising stock prices creating a ‘wealth effect’. Needless to say, it is this ‘process’ - as it was pushed to the extreme - that helped produce the unsustainable booms and busts that dotted Greenspan’s Fed (and just for record, most investors do not consider themselves ‘fortunate’ for having participated in this ‘process’).  As for current Fed boss, Ben Bernanke, he is of the mind that no “obvious” asset price bubbles can currently be identified.  Not that he would know, of course, given that he has never actually pointed one out.

With the Fed pledging to keep interest rates low well into the future, it is not unthinkable that today’s liquidity and dollar carry investment platforms will continue to attract an even larger crowd of followers.  However, while everyone believes they will be able to see the exit lights before the inevitable bust arrives, the unfortunate reality is that most will perish.

In short, liquidity explains why asset prices are booming today, and the death of the dollar carry trade will be the explanation given when asset prices go bust. What can not be explained is why anyone still has faith in the idea that the Fed can orchestrate sustainable asset price booms.  Save a deflationary conflagration, easy money Fed policies always fuel unsustainable asset bubbles!

By Brady Willett
FallStreet.com

FallStreet.com was launched in January of 2000 with the mandate of providing an alternative opinion on the U.S. equity markets.  In the context of an uncritical herd euphoria that characterizes the mainstream media, Fallstreet strives to provide investors with the information they need to make informed investment decisions. To that end, we provide a clearinghouse for bearish and value-oriented investment information, independent research, and an investment newsletter containing specific company selections.


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in