Liquidity data point to financial trouble ahead – CrossBorder Capital
CrossBorder Capital, the UK based independent advisory and alternative fund manager, has said its headline Global Liquidity Index (GLI) points to a general improvement through February, but that other data suggest some key challenges to financial markets in coming months.
The GLI hit 62.1 in February, up from 58.1 the previous month. The range is 0-100, with a higher number suggesting an improvement in global liquidity.
However, Mike Howell (pictured), managing director, said that there were other data that seen in the context of market developments pointed to challenges ahead.
The first of these is the appreciation of the dollar. This is because a strong dollar effectively means monetary tightening elsewhere in the world, Howell said. It could affect European banks who are lending dollars themselves or providing dollar based products. The problem inherently stems from the fact the dollar is “a global currency but there is no global central bank,” he said.
Meanwhile, the history of liquidity cycles points to another banking crisis. The cycles historically have lasted 8-10 years, and arguably the next one should occur within the next few years, Howell said. The ECB is precipitating a crisis by tightening its own balance sheet in recent months. There is also a link to financial markets; Howell said that if the US Fed has shrunk its balance sheet to the same extent as the ECB, then the recent highs noted on Wall Street would have been unlikely.
Further analysis of the Global, as well as other country specific liquidity indices suggests that emerging markets investors should be wary. Unless liquidity improves, for example, through regional monetary easing, then the indication is that performance of emerging markets will be hit.
CrossBorder Capital bases its indices on fund flow data from the IMF and other sources. These flows are a superior leading indicator compared to, say, national accounts data or more limited money supply data such as ‘M2′, according to Howell. The indices track data on credit spreads, available funding, cross border flows and central bank interventions in some 80 countries globally.
CrossBorder Capital defines liquidity as “a consistent quantitative measure of funding sources taken from national flow of funds accounts and using a standardised IMF template; it is a far broader measure than money and a far better measure than interest rates.”
It adds: “‘Liquidity’ reflects financial intermediation beyond the traditional banking system. Structural change renders once useful money supply measurement out-dated. Alternatively, some look to so called ‘financial condition indexes’, but these are barometers and not leading indicators. Therefore, we dig deeper into flows of funds statistics to find the roots of this ‘new liquidity’ among the shadow banks, wholesale money markets and central bank balance sheets. This we dub ‘funding liquidity’.”
Howell said he could only think of two examples where the quality of data used was questionable: one involving the regime of former president of the Philippines Ferdinand Marcos – who “fudged” figures delivered to the IMF, requiring subsequent revisions; and the other when the eurozone launched, resulting in a significant number of revisions of data around 2000.
Further data and research is available at http://www.crossbordercapital.com