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Surging Liquidity Keeps Playing Field Tilted

Composite Liquidity - Click to enlarge

The composite liquidity indicator surged to another new high last week. That was not enough to stop a sharp selloff in stocks. But when the Fed’s monthly MBS purchase settlements began on April 10, that stopped the bleeding. While there have been a number of ominous technical signals in the charts of stock prices and cycle indicators, strictly on the basis of the liquidity trend, I am forced to conclude that this was just another instance of the dealers shaking out some inventory before marking them up and distributing them again.

Composite Liquidity - Click to enlarge
Composite Liquidity – Click to enlarge

My analysis has 3 components. Price, time, and liquidity. If all 3 are not in gear, then it’s difficult to see a sustained move in either direction. My observation has been that that is particularly true of liquidity, so I tend to give it a bit more weight in the analysis. Time may prove that leaning wrong, but so far, I have not seen enough evidence to end that bias.

The $10 billion reduction in weekly Fed POMO purchases under the latest FOMC directive went into effect this month but the dealers will still be getting around $70 billion a month from those purchases. Add to that the cash flowing into dealer accounts from the BoJ, and the rumblings that China is relenting on its tighter monetary policy, and that’s still a garishly tilted playing field. In addition, the Treasury is stuffing cash back into dealer and investor accounts this month (see Treasury update).

This report covers the details with charts illustrating the trends, with brief explanations of the analysis and conclusions.

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