The second of two important articles from Tyler Durden at zerohedge.com, citing Citi’s analyst Matt King:
Earlier today we showed an amazing schematic courtesy of Citi’s Matt King: if one includes the reserve liquidation by various EMs and SWF, and nets it against liquidity injections by DM central banks (and the PBOC), one gets a perfect quantitative, not just qualitative, walk-thru on how to trade markets: in other words one can measure, using high frequency data in real-time, just where markets should trade based on liquidity flows, and promptly profit from any arbitrage opportunities.
But aside from the potential for substantial profits, there are more profound implications. Matt King lays them out as follows:
If this relationship were to continue to drive markets, it would point to three conclusions.
First, if outflows from EM continue to be “worse than previously thought”, as the IIF put it this week, that may continue to weigh also on developed markets. We recommend the IIF’s monthly ‘portfolio flows tracker’ as the best high-frequency indicator as to how those flows are developing; we also use data from those EM central banks that promptly publish reserves information as a guide to the broader universe.
Second, the relationship suggests individual central banks are considerably less in control of their own destinies than they might have hoped. Our rates strategists have already pointed out that long-term inflation expectations in Europe and the US have more in common with a global – Chinese – factor than with domestic wage and price developments. With the current magnitude of EM outflows seemingly entirely offsetting ongoing ECB and BoJ QE, it seems fair to wonder whether the sorts of increases likely from the BoJ next week and the ECB in March will have as great an effect as investors seem to be hoping.
Third, the fact that just one variable, with nothing in common with credit or equity fundamentals at all, does such a good job of explaining changes in market prices is in itself disturbing. It points to just the sort of herding effects we have argued were in play all along, and suggests that recent complaints of illiquidity, and sudden bouts of volatility, are being driven by more than just regulatory constraints on dealer balance sheets. Such a relationship leaves little room for heterogeneous market views.
To continue reading: With EMs and SWFs Pushing Markets Lower, Here Are The Three Dramatic Conclusions
