All That Pandemic Liquidity Finally Led to Erosion

Water Flowing Underground

Such excitement! The Russian army begins to withdraw from the Ukrainian border, or does it? Five nominations to the Federal Reserve are about to be voted on, and then they aren’t. Share prices go down and go back up, but so do bond yields.

Rather than attempt to follow every twist and turn of the geopolitical drama, or all the excitement in Washington, it might be best to focus on the most vital commodity market — liquidity.

Mike Howell of Crossborder Capital Ltd. in London is the doyen of liquidity analysts. By his measure, the liquidity created by central banks has stopped growing and is now in a significant decline. It is the second derivative of the change in the speed with which liquidity is flowing that has the greatest impact on markets:

This matters because the great post-Covid rally has been driven almost exclusively by the provision of extra liquidity. As Howell has demonstrated in the past, the rise in share prices has been achieved merely by by diverting a normal amount of new liquidity into stocks, and is not driven by any over-exuberant increase in allocations to equities.

As he shows, provision of liquidity and the creation of wealth through higher asset prices are intimately connected over time. Falling liquidity, while obviously necessary now that the emergency has passed and inflation is rising, could well signal problems ahead: