Figure 5 shows the rolling 3m combined liquidity injection by the Fed, the ECB, the BoE and the BoJ, plotted against the rolling 3m change in spreads. While the relationship is not perfect – liquidity flows across asset classes and across borders, and there are announcement and confidence effects in addition to the straightforward impact on net supply – it is this, not fundamentals, which we would argue has been the major driver of markets for the past few years(Figure 6 shows the same series plotted against global equities).
In case anyone missed it, and in case there is still any debate about this issue which we first explicitly stated nearly 6 years ago and were widely mocked by the all too serious intelligentsia, here is the key sentence again:
“it’s the liquidity injections, not fundamentals, which we would argue has been the major driver of markets for the past few years.”
And with that piece of New Normal trivia behind us, we continue:
For over a year now, central banks have quietly being reducing their support. As Figure 7 shows, much of this is down to the Fed, but the contraction in the ECB’s balance sheet has also been significant. Seen from this perspective, a negative reaction in markets was long overdue: very roughly, the charts suggest that zero stimulus would be consistent with 50bp widening in investment grade, or a little over a ten percent quarterly drop in equities. Put differently, it takes around $200bn per quarter just to keep markets from selling off.
If anyone ever needed any confirmation of what we said in June 2012, that “The Stock Is Dead, Long-Live The Flow: Perpetual QE Has Arrived“, now you have it, and only qualified but quantified. Because to translate what Matt King – Citi’s most respected strategist and the only person on Wall Street to warn about the Lehman collapse and its consequences before it happened, just said – if and when the global central bank liquidity tracker ever drops to $200 billion per quarter or less, the market will crash.
This article is brought to you courtesy of Tyler Durden From Zero Hedge.