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Markets fear another “delta”: Mike Dolan

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09/10/202127 minutes agoRead for 4 minutes Join the conversation

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LONDON – Facing the economic disruption from the delta variant of COVID-19, financial markets are equally concerned about another “delta”: the declining rate of global credit creation.

As always, the formation of market prices is determined more by new developments than by absolute values. The most recent change, expressed in mathematics by the Greek letter delta, is most important in pricing. For this reason, economic data and “surprises” in corporate earnings typically move markets rather than overall levels of national production or corporate earnings per se.

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So while some investors struggle to see where this post-pandemic stock market bull market will end, while interest rates remain so low, global liquidity so abundant, and growth so strong, strategists warn that the direction of things is going on with all of these things Should be cause for concern.

The aggregate global liquidity pool generated by central banks and personal loans – viewed by many as the dominant factor in global assets – is still growing. But the change in that growth, also known as the delta or “credit impulse,” is slowing sharply and could soon turn negative.

Citi’s global market strategist Matt King points to the combination of slower central bank bond purchases and bank reserve building, weak personal credit growth, and the near end of the US Treasury’s stacks of cash being run down by the Federal Reserve.

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King, who identified these Treasury General Account (TGA) drawdowns as a potential second wave of global liquidity to stimulate markets earlier this year, said the waning general credit momentum should now be watched.

“The hope is that with real returns still low, this could only mean a reduction in the current market excess,” he wrote this week. “But history suggests greater caution.”

“Typically, it takes a positive delta to sustain the market rally – and the immediate outlook for both the credit and COVID delta seems overwhelmingly negative.”

King’s Number Crunch of this credit impulse looks at the biannual change in bank reserves created by the world’s largest central banks when they buy bonds from the market. Taking into account the moderate cuts in bond purchases by the Fed and the European Central Bank by the end of the year, he expects the pace of bank reserve growth to halve from this year’s highs.

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The near end of the trillion-dollar TGA rundown, which mechanically boosted US bank reserves at the central bank, is partly responsible.

But the bigger slowdown he notes is in the pace of private credit creation – which accounted for about two-thirds of the $ 17 trillion in new credit last year, while central banks made up the rest.

As measured by a rolling 12-month change in the flow of new personal credit, that credit impetus – weakened by a slowdown in China, high levels of corporate liquidity, and government support during the pandemic – is on the verge of going negative in any region, King estimates.

IMPULSIVE

Nikolaos Panigirtzoglou’s flow and liquidity team at JPMorgan believes the US Treasury Department’s liquidity impact of $ 1.35 trillion from its Fed account is negatively impacted by the associated decrease of more than $ 900 billion outstanding Treasury bills and also were offset by the Fed’s daily reverse repurchase operations of over trillion dollars.

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In addition, the debt ceiling stalemate further complicates the picture in the coming months, the team said.

However, JPMorgan stressed that growth in central bank buying of bonds and growth in private sector lending were more important to world markets in the medium term, and both would indeed weaken.

However, global flow analysis can be nebulous.

A common assumption is that central bank purchases of bonds will be reduced and liquidity will lead to higher benchmark lending rates and generally curb the flow of credit.

But liquidity analyst Mike Howells CrossBorder Capital has cast doubts as to whether this is true – not least given the seemingly “perverse” decline in US Treasury yields this summer, even as growth and inflation skyrocketed and the Fed tightened US government bond yields. Treasury bonds and a resumption of large US Treasury bond sales loomed.

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However, “excess liquidity” measures that offset sales of new government bonds versus central bank purchases actually correlate positively with so-called term premiums of bond yields – the portion of yields that captures the uncertainty of long-term bond holdings.

With the excess liquidity this year, these term premiums also decline – the opposite of what most textbooks and policy makers suggest.

CrossBorder explains this by saying that less liquidity from the Fed can lead to higher demand for “safe” bonds – either as a countermeasure against more corporate failures or possibly even to be used as “pure” collateral in repo deals to repo the lost Increase liquidity this way instead.

Similarly, liquidity depletion due to higher debt sales can also stimulate demand for this safe bond collateral to get the maximum liquidity through repo.

Ultimately, however, CrossBorder sees this as a function of increasing total debt, which in one way or another has to be financed by creating liquidity and thereby suppressing global economic growth.

“Rising debt levels could explain the perverse reaction: we have too much debt, not too much liquidity,” she concluded.

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

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