This chart tell us more about what is happening in financial markets than any other
Head of Macro Analysis
Summary: There is one thing that really matters more than others, and it is global U.S. dollar liquidity. The bad news is that it is in contraction for the first time since early 2019. Usually, this is a synonym of market turmoil and higher risk aversion. We consider this is certainly one of the most important and less mentioned drivers behind the continued drop in financial markets in recent months.
This is a fact : we operate in a dollar-based world. Therefore, U.S. dollar liquidity serves as a key driver of the global economy and financial markets. At Saxo Bank, the evolution of U.S. dollar money supply is our favorite dollar liquidity indicator. In the below chart, we track U.S. dollar liquidity based on the evolution of the monetary aggregate M2 in the twenty-five largest economies converted into U.S. dollar and minus the evolution of M3 in the United States. This is certainly the most important chart to understand what is currently happening in financial markets.
In the wake of the outbreak, U.S. dollar liquidity increased reflecting efforts from the U.S. Federal Reserve and other major central banks to avoid a liquidity crisis similar or worse than that of 2007-08. It was successful. Since mid-2021, U.S. dollar liquidity has slowly started to decrease. But liquidity remained abundant until very recently. The liquidity issue on the UK bond market, which triggered an emergency intervention from the Bank of England, is one example of what may happen in the coming months if liquidity, especially U.S. dollar liquidity, is scarce. The two last times financial markets went through such a contraction in liquidity, it was in 2015 (when China devalued the CNY) and in early 2019 (at that time, the focus was on the Chinese-U.S. trade war). It caused an emerging market turmoil, deteriorated financial conditions and higher U.S. dollar funding costs. But there is one major difference compared to 2015 and 2019, there was no inflation at that time. It is now the single one major issue for policymakers. Given inflation will remain volatile in the months to come and that it has not peaked in most countries (with the exception of the United States), central banks have no other choice but to keep normalizing monetary policy. This means that U.S. dollar liquidity will continue to fall in the short-term. It will have a net negative impact on financial markets, especially the equity segment, and the global economy (for more on our Q3 earnings expectations, see Peter Garnry’s latest article).
Latest Market Insights
Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.