Following a lament by Urjit Patel, the head of the Reserve Bank of India, who three months ago predicted (correctly) that the Fed’s tightening coupled with the shrinking of its balance sheet and the ramp-up in Treasury issuance would result in a dollar liquidity shortage and that “a crisis in the rest of the dollar bond markets is inevitable” unless something changed, we showed how shrinking liquidity as a result of Quantitative Tightening had emerged as the main culprit for the turmoil and “rolling bear markets” that have hit the rest of the world, courtesy of the showed how.
Picking up on the topic of shrinking dollar liquidity and broad money supply, BofA’s Barnaby Martin today notes that much more pain is in store as the Fed’s withdrawal of the punchbowl looks to be far from over; in fact, the Fed’s balance sheet declined by a significant €60bn in August, the biggest monthly decline seen yet in this tightening cycle, adding that last Friday’s healthy US wage growth data will only support the Fed’s resolve to push on with monetary policy normalization.
More importantly, Martin observes that the Fed’s QT (Quantitative Tightening) “is having the effect of pulling global capital out of those pockets of the economy that were the big beneficiaries of the post-GFC reach for yield” such as Emerging Markets and, of course, stock markets around the world.
And in what may be the best chart showing the culprit behind the recent EM turmoil, the BofA strategist shows that this year’s Emerging Market vulnerability has coincided with the sharp deceleration in central bank balance sheet growth.
This, in turn, has led to the biggest ever differential in Emerging Market vs G-10 currency vol as EM traders have been scrambling to avoid getting burned by the rising price of the dollar.
