Markets, still awash with cash, are in calm for now

By Naomi Rovnick and Harry Robertson

LONDON (Reuters) – Rising interest rates, slowing economic growth and a banking sector still recovering from March's bust may indicate a cautious market stance, but world stocks are at a 14-month high, the S&P 500 -stock index has entered a bull market and volatility indicators are eerily quiet.

For some, the answer to the ebullient markets lies in the fact that there is still plenty of cash sloshing around in the financial system. But it may not last, especially as the US Treasury may pull funds and risk appetite out of markets as banknote issuance surges.

BNP Paribas estimates that excess global liquidity has risen by $640 billion since the end of Q3 2022 and is “unsustainable” as some central banks seek to unload bonds they hold in a process dubbed quantitative tightening.

As the second half of 2023 approaches, the environment could become more challenging for risky assets, which currently benefit from ample liquidity.


At least in the short term, analysts expect risky assets to remain dynamic.

The Federal Reserve eased funding conditions in March with an emergency lending facility for banks suffering from cash shortages. The Bank of Japan is still buying government bonds to inject money into the system, and the European Central Bank is selling the government bonds it holds on easy terms at pace.

Crossborder Capital founder Michael Howell notes that “Japan is creating liquidity” while “we expect further monetary easing in China”.

Total global liquidity, a measure of cash and credit in the global economy, rose to nearly $170 trillion in June from $158 trillion in October, according to Crossborder calculations.

Central banks are estimated to have injected $1.7 trillion net into money markets since November, a move that correlates with a risk-on trend.

Global stocks are up 11% year-to-date, helped by a rebound in US tech stocks on an AI boom. The VIX index, a measure of implied volatility dubbed Wall Street's “fear gauge,” hit its lowest level since early 2020 last week February observed values.


Liquidity is made up of “many moving parts,” said Richard Clarida, a former vice chairman of the US Federal Reserve and now global economic advisor at bond fund PIMCO. He said the US debt ceiling deal could be a “wild card” depending on who buys a wave of new bonds.

The US Treasury will clean up its overall balance sheet by issuing $1 trillion or more in short-term debt securities, potentially at interest rates attractive enough to siphon cash off riskier assets.

It could also affect banks' ability to lend as they raise deposit rates to compete with government bonds, reducing the flow of credit to businesses and consumers.

Georgina Taylor, multi-asset chief at Invesco, said the company prepared for the downturn by holding a long position in the dollar, which is usually beneficial when investors become more cautious.

However, an alternative scenario is that US money market funds, stuffed with cash after depositors fled regional banks in March, buy enough newly issued Treasuries to keep interest rates stable.

Your money tends to go into reverse repos, a Fed facility that offers generous interest rates for storing money overnight, and could go into T-bills instead, said Amundi US chief investment officer Ken Taubes.

This money shift “basically from one government pocket to another,” Taubes said, is “one of the reasons markets are reasonably calm about this issue.”


BNP Paribas said its baseline scenario is for global liquidity to fall by 6-9% by the end of September and by 7-11% by the end of the year, but liquidity is not the only reason for the current upbeat sentiment.

“Liquidity is not a force that directly affects financial markets,” said Nikolaos Panigirtzoglou, global market strategist at JPMorgan.

Alongside the AI ​​boom, strong balance sheets and plenty of cash at tech megacaps like Apple are attracting investors to these stocks, which dominate global equity indices.

Still, Morgan Stanley said in a statement that it remains bearish on equities amid expectations of an earnings recession, and Luca Paolini, Pictet Asset Management's chief strategist, said he was “underweight” equities in anticipation of a credit crunch and buying government bonds afterwards Recession.

“There's a lot of money in the world, and every time we see positive surprises (economic or profit-related), people put that money to work,” Paolini said. “But there are big risks that the market is ignoring, so we're still braced for weakness in risky assets.”

(Reporting by Naomi Rovnick and Harry Robertson; Editing by Dhara Ranasinghe and Kirsten Donovan)

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