By Peter De Coensel,


The Bank for International Settlements (BIS) tracks global liquidity indicators. They define these as follows: the term “global liquidity” refers to the ease of financing in global financial markets.

Since early 2022, the synchronised policy rate tightening by developed market (DM) central banks has been sapping monetary liquidity provisioning whilst in parallel financing conditions across bank and non-bank (through debt capital markets) channels have tightened. The US FED leads and controls the dance. The US central bank combines tightening of policy rates, currently at an effective 4.58% level, whilst reducing balance sheet assets at a clip of USD 60 billion per month for Treasuries and USD 35 billion on MBS (Mortgage-Backed Securities) issued by government sponsored enterprises.

On the liability side, reserves on the FED’s balance sheet (for clarity: during quantitative easing (QE) the Fed paid for large-scale Treasury an MBS purchases through the creation of reserves, which represent cash balances that banks hold at the Fed and on which the Fed pays interest) are now falling by USD 95 billion a month, USD 285 billion a quarter or USD 1.14 trillion a year. Such tightening is USD supportive. We’ll come back to that in the last paragraph.

There is a direct link with bank lending standards as shrinking bank cash balances at the FED pass-through in tightening standards applied by banks to (SME) borrowers and/or credit lines across corporates. Indeed, money supply is contracting, and credit availability is getting more constrained. On top, the longer yield curves remain inverted-to-flat the more banks get constrained in proper interest rate transformation.

Tightening lending standards combined with worsening liquidity conditions might start impacting credit risk profiles of companies. The impact is broad-based and ranges from IG and HY corporates that are publicly funded through debt capital markets or corporates that tap private debt markets.

During the first quantitative tightening (QT) episode in 2018, FED governors explained the balance sheet runoff process as ‘watching paint dry’. FED governors tried to convince the public that QT would not have the same announcement effects as QE. Notwithstanding, current FED papers reveal that as the total supply of reserves shrinks, each additional dollar of reserves drained will have a greater effect on interest rates and overall liquidity conditions. One can expect that, by the end of 2023, liquidity conditions will have worsened considerably. Why? Well, whilst the balance sheet runoff over Q2 & Q3 will be cushioned by liquidity injections as the Treasury department draws down on its Treasury General Account (TGA) at the FED. Janet Yellen wants to prevent debt ceiling issues at all costs. One can expect that the debt ceiling stand-off will get resolved over September this year. At that moment the Treasury will rebuild the TGA towards the USD 500 billion-USD 750 billion range. Over Q4, QT (USD 285 billion) + TGA rebuild might cause a liquidity drain of around USD 900 billion. Increasing risk of reserve shortages might lead to credit crunch anxieties.

The disinflationary ‘goldilocks’ that markets are experiencing today could morph into a deflationary bust if and when central banks keep policy rates high for too long.

Over Q3, terminal US and ECB policy rates have been priced at respectively 5.50% and just above 3.50%. That leads to deeply negative observations of about -1.0% on the differential between 5Y5Y forward US Treasury rates at 3.57% with the effective FED fund rate at 4.58%. Such conditions of high policy rates and distinctly lower longer-term rate estimates were present over 2006-2007 as well as 2000. Subtracting 2.50% ECB depo rates from 5Y5Y German forward rates at 2.36% leads to a -14bp differential. Expect this negative print to fall further over H1 2023. Historically, such tight policy & liquidity conditions implied by sticky yield curve inversions were precursor to aggressive credit widening 12 to 18 months ahead. The lags of monetary policy will be felt most over 2024.

On top, US personal savings rates as a % of disposable income ended the year at 3.4%. The long-term average sits around 9%. An increase of savings rates towards the average over the next 24 months will impact nominal growth and corporate earnings over 2024. FED fund futures do point at policy rates back below 4% over 2024. Expect the FED to also be forced to cease balance sheet run-off.

The Eurozone savings rates by the end of Q3 had dropped towards 10.8%, about 3% below the long-term average. Again, the moment savings rates rise, the impact on nominal EU growth might be felt. Debt management agencies are aware that, as long as long-term funding rates remain below the long-term nominal growth rates, a reverse snowball effect ensues with improving debt to GDP ratios under orthodox fiscal policy. However if nominal growth starts printing below average long-term funding rates and fiscal expansion is persistent, debt sustainability questions flare up. The FED and the ECB are aware. Interest expense as a % of GDP made a low over 2022. With the increase in long-term rates, governments will see their interest cost rise over the next years. Many, not all, debt management offices pushed out the average duration of government debt. That will buy many countries time. However, the trend has reversed. Higher cost of debt will crowd out investment budgets and depress long-term growth potential.

The above set of indicators might become USD supportive over H2 2023. Declining domestic and offshore USD money supply reduce offshore USD trade flows and offshore credit growth by governments and corporates. The demand for USD in order to redeem outstanding liabilities (cash and derivatives claims) will remain strong. A revisit of EURUSD lows is still in the cards. As we discussed the potential inversion peak over H1 2023…could we observe an attractive, at 4.03%, entry point in intermediate US 5-year Treasuries? Uncertainty is elevated. A lot of boxes are ticked. Risk-free government bonds attract as we go into the last innings of the tightening cycle(s). Central banks should act carefully here and now as policy mistakes lure around the corner.


Degroof Petercam Asset Management SA/NV l rue Guimard 18, 1040 Brussels, Belgium l RPM/RPR Brussels l TVA BE 0886 223 276 l

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