29th July 2013
Fears about global liquidity may well be over-blown and discussions about tapering may be missing the point says HSBC Private Bank’s UK Head of Investment Strategy Willem Sels.
In a note issued this week, it says that there are many signs that liquidity is filtering through to the real economy and that is should support a wide range of assets, but equities in particular.
The note adds: “For many weeks now, markets commentators have been almost exclusively focused on the announcement of potential tapering by the Federal Reserve. We are getting somewhat bored by the discussion, which centres around the timing of the tapering – starting in September, or, as we believe, in December – the pace of it – QE ending in mid-2014 or, as we believe, by end 2014 – and the trigger – unemployment above target, and falling PCE inflation – suggest to us that there is no immediate trigger.
“We think the discussion misses the point that global liquidity remains ample. First and foremost, tapering refers to ‘less significant buying’ of US Treasuries or mortgage-related product; it does not mean that the Federal Reserve will be selling bonds in the near future. Second, liquidity is a global resource, and the focus on the US ignores what is happening elsewhere, in particular in Japan.”
The note adds: “The balance sheets of the major central banks have grown, and should continue to grow, as Japan plans to add about USD70 billion to its balance sheet each month. Even if the Fed starts to taper in September and stops quantitative easing completely by mid-2014, the ‘quick tapering’ scenario, global liquidity should remain ample.”
Two threats, but they can be overcome
However Sels says he watching for two red flags which could limit liquidity – the Japanese repatriation of funds and falling corporate bond issuance, but he adds that he believes that with some stabilisation in Treasury yields, these challenges should also be overcome. He assesses these below
1. Corporate bond issuance
“Access to the corporate bond market has fallen in recent weeks because of heightened Treasury volatility. This has hurt both investment grade and high yield issuers across the world.
“This is a potential threat to corporate liquidity and hence to growth, but we think that it can be overcome. First, there are alternatives as bank lending and commercial paper markets are healthy.
“Moreover, we think that issuance will come back as Treasury market volatility eases. With 10-year Treasury yields now hovering around 2.50%, we have already seen increased issuance come back to the market in recent days.
2. Japanese investment flows
“We noted above that liquidity injections by the Japanese central bank should be good for global liquidity and financial markets. Again, though, this should only help global asset prices if that liquidity flows out of the country.
“So far though, Japanese investors have repatriated money back home, as shown below, because of the rapidly improving local economic outlook and strong momentum of the Japanese stock market. Indeed, among major equity markets, Japan has the highest ratio of analyst earning upgrades / downgrades, causing investors to keep money at home.
“ Local investors may continue to find attractive opportunities in Japan, but we think that they will, with time, start to invest abroad again. Triggers for such a reversal of flows may be a stabilisation in US Treasury yields or credit spreads, the current high yield differential between Japanese and US Treasuries (or European bonds for that matter), the potential for further JPY weakness, or any easing of emerging market growth concerns in the months ahead.”
The note concludes: “As Mr Bernanke has pointed out, QE tapering is not a removal of USD liquidity – it is a slowing of liquidity expansion. Moreover, global liquidity should continue to expand. This liquidity is increasingly feeding through into the economy and into markets, and we think that any easing of Treasury yield volatility should help overcome the two hurdles we are seeing (corporate bond issuance and Japanese fund repatriation). Ample global liquidity should continue to help push asset prices higher, in particular in the equity market.”