Column: Markets fear another “delta”

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LONDON (Reuters) – With an eye on the economic disruption of the Delta variant of COVID-19, financial markets are equally concerned about a different “delta”: the ebb rate of global credit creation.

Sheets of former US President Abraham Lincoln on the five dollar bill are displayed at the Bureau of Engraving and Printing in Washington on March 26, 2015. REUTERS / Gary Cameron

As always, market prices are determined more by new developments than by the absolute. The last change, expressed in mathematics as the Greek letter delta, matters most in pricing. This is why economic data and corporate earnings “surprises” usually move markets and not the overall level of domestic production or corporate profits per se.

And so, as some investors struggle to see where this post-pandemic bull market will end as interest rates remain so low, global liquidity so plentiful, and growth so strong, policy makers warn that the leadership of the trip over it all should be a good reason for concern. .

The aggregate global pool of liquidity generated by central banks and private credit – which many see as the dominant engine of global assets – continues to swell. But the course of this growth, otherwise known as the delta or “credit impulse”, is slowing down sharply and could soon be negative.

Citi global markets strategist Matt King points to the combination of a slowdown in central bank bond purchases and bank reserve building, weak private credit growth and the near end of the debt reduction. US Treasury from its liquidity to the Federal Reserve.

King, who at the start of the year identified this withdrawal from the General Treasury Account (TGA) as a potential second wave of global liquidity to lift markets, said the weakening aggregate credit impulse now deserves attention. ‘to be watched.

“The hope is that with real returns still low, this may simply imply a reduction in the current market exuberance,” he wrote this week. “But history calls for more caution.”

“It usually takes a positive delta to keep the markets recovering – and the immediate outlook for credit and COVID deltas looks extremely negative. “

King’s digital analysis of this credit impulse examines the semi-annual rate of change in bank reserves created by the world’s largest central banks when they buy bonds in the market. Given moderate cuts in Fed and European Central Bank bond purchases by year-end, he calculates the pace of bank reserve growth is expected to halve from this year’s highs. .

The near end of the trillion-dollar TGA decline, which mechanically increased US bank reserves at the central bank, is partly to blame.

But the most significant slowdown he points out is the pace of private credit creation – which accounted for about two-thirds of the $ 17 trillion in new credit created last year, with central banks making up the rest.

Measured by a rolling 12-month change in the flow of new private credit, this credit boost – weakened by a slowdown in China, high corporate cash levels and government support during the pandemic – is set to turn negative in the pandemic. all regions, says King. .

IMPULSIVE

Nikolaos Panigirtzoglou’s cash flow team at JPMorgan estimates that the cash impact of the $ 1.35 trillion withdrawal from the Treasury to his Fed account was offset by the related drop of over $ 900 billion. dollars of outstanding treasury bills as well as daily Fed reverse repo transactions of over $ 1 trillion.

Moreover, the impasse on the debt ceiling further complicates the situation in the coming months, the team said.

But JPMorgan pointed out that the growth in central bank bond purchases and the growth in lending to the private sector were more important to global markets over the medium term, and that both factors were indeed weakening.

However, the analysis of global flows can be nebulous.

A general assumption is that a reduction in central bank bond purchases and liquidity will lead to higher benchmark lending rates and suffocate credit in general.

But liquidity analyst Mike Howell’s CrossBorder Capital questioned that this rings true – especially given the apparently ‘perverse’ drop in US Treasury yields this summer even as growth and inflation rose, and that the Fed was shrinking and a recovery in sales of large Treasury debt was looming.

However, the “excess liquidity” measures that offset new sales of government debt against central bank purchases are actually positively correlated with term premiums in bond yields – the portion of yields capturing the uncertainty of the bond yields. holding long-term bonds.

So, as excess liquidity declines this year, those term premiums have also declined – the opposite of what most textbooks and policymakers might suggest.

CrossBorder explains this by saying that less liquidity creation by the Fed can lead to increased demand for “safe” bonds – either as a defensive measure against more corporate defaults, or perhaps even to use them as “premium collateral.” In repo transactions to increase the lost liquidity in this way. instead of.

Likewise, liquidity depletion due to increased sales of debt securities may also stimulate demand for this safe bond collateral to obtain maximum liquidity through the repo.

Ultimately, however, CrossBorder sees this as a function of the skyrocketing aggregate debt levels that need to be funded by creating liquidity, one way or another, and thus may undermine growth. global economy.

“Rising debt levels may explain the perverse response: we have too much debt, not too much cash,” he concluded.

by Mike Dolan, Twitter: @reutersMikeD; Editing by Pravin Char


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