The liquidity slump and the yield curve

Who Stole Liquidity? The Outlook For US TreasuriesThis report takes a ‘liquidity view’ of the US yield curve and rates. Although Global Liquidity growth is tanking at a worryingly rapid rate, bond market flows look to be more in balance. We do not expect the US Treasury yield curve to invert and it is more likely to gently steepen from around current levels. Yield curve movements depend both on term premia (largely via the long-end) and rate expectations (largely via the front-end). Aggressive rate expectations could drop back, but the low prevailing level of policy rates means it is unlikely they can fall by much. More likely is rising term premia from their unusually depressed levels. Two factors driving term premia higher are: (1) growing supply of US debt and (2) diminishing appetite for US assets from foreigners. According to a ‘liquidity view’, the ‘long-end drives the short-end’ and not vice versa. This will mean two more Fed policy rate increases. US 10-year bonds are likely t…

Does the Yield Curve ever lie?

Recession Watch – Yield Curves Can Predict Future Crises, But You Have To Focus More on Curvature and Term Premia Than SlopeThis report argues that the yield curve slope, by itself, is not a robust predictor of future recessions. Other yield curve parameters need to be taken into account and, specifically, the size and position of the curvature hump in the term structure. In other words, we emphasise curvature and, by implication, the importance of term premia. Not only have term premia recently fallen in size – so indicating greater demand for ‘safe’ assets by investors – but their distribution has become more positively skewed, which has been a better predictor of upcoming recession than the simple yield curve slope. The implication is that the US Fed’s slated future ‘forward guidance’ path may be too aggressive.

Re-Assessing Emerging Markets: What Now?

As Global Liquidity conditions tighten further, we accept that the next few months will prove more challenging for Emerging Markets. Credit is a particular problem and the downside risk is that EM debt spreads could add a further 200bp versus US Treasuries. However, a positive note is that EM domestic fundamentals look far better than during previous crisis periods. In particular, net capital inflows appear surprisingly firm in contrast to recent Press reports. In sum, the EM outlook is poor largely because of external factors, but domestically it does not look a disaster.See our latest published research, Global View Re-Assessing Emerging Markets: What Now?July 2018Please find either a link to our website, or an email attachment.  For further information, or to change user options, please contact us at
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Liquidity is being drained fast...

The Tide Is Going Out…FastHaving previously warned of gathering problems from Q2, the economic and financial news flow is getting worse not better, and we believe asset markets are increasingly vulnerable to a meaningful shake-out. Risk appetite levels remain elevated and yield curves are flattening against a backdrop of fast tightening Global Liquidity. Not only are the two critical channels – Central Bank liquidity and cross-border flows – in retreat, but China, which dominates the pool of World savings, is now halting their recycling back into Western markets.

Red Alert

Red Alert for Markets? PBoC Watching Signals Danger AheadNever say never in financial markets. On paper, China’s PBoC has few reasons to tighten in 2018, but latest data show the People’s Bank squeezing moderately. This may be a temporary blip, but the huge size and influence of the PBoC makes it a critical factor to watch.

Why Asia Really Is Different This Time

There is an ever more distinct Asian financial cycle. Structural economic changes are altering the shape of the World economy, largely, in recognition of China’s increasingly dominant role. Policy-makers are responding. We do not mean by this the latest reactive moves by US President Trump, rather the longer-term strategic adjustments being implemented by Asian regional policy-makers. Foremost are the implied shift by Japan towards Yen-targeting and the suggestion that China has stopped building forex reserves. If we are correct, these moves prospectively represent the biggest policy changes in Asia for three-decades.

Emerging Market Crises - When to Push the Panic Button?

We continue to be more concerned by developments in the core economies than in EMs, but we also acknowledge that when the liquidity tide goes out, then EMs can look vulnerable. In this report, we argue three things: (1) every EM crisis is first-and-foremost a currency crisis; (2) EM fundamentals appear far stronger than in past EM currency crises, and (3) the Chinese economy is now more important than the US economy to the fortunes of EMs. Although we remain negative about global markets, we are more upbeat about medium-term EM prospects and conclude that the latest shake-out is nothing like 1997, 2001 nor 2008. Therefore, buying into EM weakness makes sense.