It’s still all about the central banks. If you care about allocating money between global assets, everything else remains ancillary, and all 2019’s biggest trends — from negative interest rates in Germany through the inverted U.S. yield curve to the impressive global rebound in share prices — can be explained by the actions of central bankers.
Many will find this rather depressing. Approaching the end of an exciting year for world markets, it is tempting to rely on a narrative of geopolitical intrigue and trade wars. But it is far simpler and more accurate to explain 2019’s events in terms of the liquidity that the developed world’s central banks have unleashed — while China and the bigger emerging markets have prominently refused to follow the same.
CrossBorder Capital, a London-based investment group, maintains indexes of global liquidity, covering central banks, international financial flows and domestic private-sector liquidity. Numbers above 50 show expansion, and a rising number shows acceleration. They show a dramatic shift in 2019.
The year started with the developed world’s central banks trying to dry up liquidity and return to normality after the crisis years, while their counterparts in the emerging world pumped money into their economies. Since then, there has been a 180-degree turn:
Jerome Powell, chairman of the Federal Reserve, protests that nobody should put the label “QE” on the U.S. central bank’s decision to expand its balance sheet in the last two months to address disruptions in the repo market for short-term bank funding. But the financial markets don’t recognize this distinction. In conjunction with asset purchases from the European Central Bank (which does describe what it is doing as QE) and the Bank of Japan, provision of liquidity has accelerated faster in the past few months than at any time since the first desperate days after the 2008 Lehman Brothers bankruptcy.
The story in the emerging markets, which these days are dominated by China, is the polar opposite. At the beginning of the year, liquidity was expanding, and the People’s Bank of China appeared to be trying to repeat its trick from 2016, when a big expansion in credit averted a slowdown. Since then, however, emerging-market central bank liquidity has dried up, and is now as tight as it has been since the series started in 2005. Contrary to the hopes of a year ago, it appears that the PBoC has been engaged in cleaning up balance sheets and helping local governments to cut back their debts in the Chinese shadow banking system, rather than making any concerted attempt to stimulate the macro economy.
This dynamic helps to explain the anomalous poor performance of emerging-market currencies. Normally, EM foreign exchange is regarded as a “risk-on” asset. If investors are feeling confident, as is typically the case when the Fed is making money plentiful, that tends to mean flows into emerging markets. But JPMorgan Chase & Co.’s emerging-markets foreign exchange index is close to its post-crisis low.
Weak emerging-market currencies open the risk of debt crises as their dollar-denominated debt grows harder to service. The emerging world remains under pressure. This isn’t just from the U.S.-China trade conflict but also, as the liquidity figures make clear, from China’s efforts to avert a financial crisis at home.
The fresh flow of money from the developed world’s central banks has allowed U.S. stock markets to set fresh highs, and spurred optimism. The greatest risk remains, as it has been for years, that China succeeds in averting a Lehman-style credit crisis at home, but at the cost of an economic slowdown that would affect the rest of the world.