What do you get when you cross US QE2 with a eurozone crisis?
Something like this chart:
That’s the difference between the US dollar and the euro overnight deposit rate — and you can see it’s been increasing in recent weeks, with the European movement very volatile. Think of it as a reversal of the 2008 ‘dollar shortage‘ (which you can see in that orange September 2008 spike). There are more and more USDs floating around, but less and less European liquidity what with the ECB gradually tightening.
Excess liquidity in the ‘wrong’ places was a point made recently by Marc Ostwald at Monument Securities, and by HSBC in relation to emerging markets. QE-caused liquidity may have effects outside its home nation, but it’s flowing through to already hotspots and not the places where it’s really needed — like, say, European peripherals.
This was from RBS’s global economics team last week:
Excess liquidity finds its way to supercharged emerging markets: the stars are aligning for an asset price bubble to form in emerging markets. Year to date, these markets have already received more inflows than in any year since at least 2004. Non-Japan Asia economies are facing a huge influx of foreign capital and are clearly struggling to manage them. As per the IIF, total private capital flows to emerging markets will be USD825bn this year (this is a new measure) and is the second strongest since 1995. The only exception was 2007 when the flows were USD1.284trn. The first line of defence has been the imposition of soft controls and/or the delaying of rate increases. We believe that the next few months will see a host of additional micro measures to try and stave off some of this hot money rather than fundamental policy shifts: we look for reserve requirement hikes, capital outflows liberalisation and a more widespread use of withholding taxes. On the FX front, more intervention is to be expected. But the forces for a bigger policy adjustment in Asia are mounting which will eventually lead to greater flexibility in currency regimes.
* but fails to reach liquidity deprived sovereigns: the irony in all this is that liquidity is flowing to countries which have already witnessed a surge in capital inflows while those that could do with some foreign investment are deprived from it with Greece, Ireland and Portugal having now largely lost access to capital markets. Meanwhile, China’s reserve accumulation in the last year (to Q3) accounted for more than Eur280bn, broadly equivalent to 200% of the 2010 annual funding requirements of Spain, Ireland and Portugal! Broader markets have largely ignored the rapid deterioration in Ireland and Portugal as if this was now a permanent feature of the European Monetary Union and there was nothing new in this. With developments in the periphery displaying very strong self fulfilling properties, we believe the crisis is unlikely to be contained to these two countries only. Markets might still be dancing to Ben’s music, but we see imminent risks that European developments might spoil the party yet again.
Misallocation of money flows, anyone?
You could shrug your shoulders and say c’est la QE — but we hear there are plenty of European market participants out there worried about the availability of euros towards the year-end — and what euro rate volatility could mean for pricing.
Related links:
Rethinking the ECB exit – yet again – FT Alphaville
Stop stealing our yield! - FT Alphaville