Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Chart of the Week : Global USD liquidity
Christopher Dembik
Head of Macroeconomic Research
Summary: Our 'Macro Chartmania' series collects Macrobond data and focuses on a single chart chosen for its relevance. This week, we focus on global USD liquidity.
Click here to download this week's full edition of Macro Chartmania.
There is one thing that really matters more than others, and it is global USD liquidity. We operate in a dollar-based world, so USD liquidity serves as a key driver of the global economy and financial markets. The evolution of USD money supply in major economies is our favorite dollar liquidity indicator at Saxo Bank. In the below chart, we track USD liquidity based on the evolution of the monetary aggregate M2 in the 25 largest economies, converted into USD and minus the evolution of M3 in the United States. This chart tells us much more than any other on what may happen in 2022.
In the wake of the outbreak, USD liquidity increased reflecting efforts of the U.S. Federal Reserve to avoid a liquidity crisis similar or worse than that of 2007-08. It was successful. Since mid-2021, USD liquidity has started to decrease. But it remains abundant. This is so far so good for risk assets. The main question for 2022 is how quickly dollar liquidity will continue to fall. The U.S. Federal Reserve has realized that there was plenty of evidence they were behind the inflation curve. Expect the central bank to speed up taper, effective from January 2022. This will lead to a drop in USD liquidity. The last time the financial markets went through such a drop in 2018 and 2019, it led to an emerging market turmoil, deteriorated financial conditions and higher USD funding costs. This time is different, in our view. It would not be surprising to see the market quickly price in at least three 25 basis point hikes for 2022, following next week’s FOMC meeting. But this is a wrong assumption. Our baseline is that U.S. inflation will remain uncomfortably high longer than the market anticipates. But the U.S. Federal Reserve will certainly be extremely careful regarding the pace of normalization in order to avoid that growth derails and the economy falls into stagflation. USD liquidity will be lower than now. This is a certainty. However, it will certainly be high enough to have a net positive effect on financial markets, especially the equity segment, and the global economy.
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