Follow Paul Donovan

Are central banks draining market liquidity?

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

  • The US Federal Reserve has increased interest rates, and will likely do so three more times this year. The European Central Bank is likely to end its bond buying later this year. The Bank of England is likely to increase interest rates within a few weeks. Even the Swiss may raise rates before the end of the year. 2018 is the year central banks tighten policy.
  • Investors worry that central banks will suck cash supply from the markets. That idea misses half the story. Investors need to think about cash demand as well. Supply and demand always matter together. Central bank policy is no different from anything else.
  • After 2008, the Fed printed large amounts of cash supply because US cash demand shot up. Today, the Fed is destroying USD 20 billion of cash supply every month because US cash demand is falling. Cash demand drops when credit or risk appetite grows. If US cash demand is falling USD 20 billion every month, then the Fed's cash supply cut is matching the demand drop. The Fed is mopping up surplus cash. No more, no less.
  • If a central bank is matching cash supply and demand in the economy, cash in the equity market will not change.