If the Fed slows the growth of US liquidity, there is always the ECB or BOJ to pick up the slack on a global basis. Liquidity is not country specific. If capital markets are open and exchange rates are flexible, money will seek a home where returns are highest and move around the world. If liquidity is cut, it will flow out of the places that are least productive and back to the home country. This may be a simple story, but it can explain the growth of global stock markets. Central banks may not care if trade is an important part of growth. The chart above shows the result. When the slope of growth is flat, stocks have decline. When the slope is steep, stocks go up.
The global markets have been lucky that when the Fed stopped QE3, soon there after the ECB announced and started their QE program. The BOJ also increased their bond purchase program when the Fed stopped their buying program. It was not coordinated but the timing was close enough to keep the liquidity growth high. Similarly, the markets have gotten an added boost from the Bank of China. A rate rise from the BOE may not matter as much globally given its size and the fact that other banks have added liquidity.
The simple heuristic is that as long as gross liquidity across major central banks is growing, investors should hold stocks. If the slope flattens, get out. However, it is notable that a unit of liquidity is not the same across central banks. The MSCI seems to suggest that there is some exhaustion associated with liquidity, but more importantly, a dollar of liquidity is different than a euro of liquidity. The dollar, as a reserve currency and as the unit of measure for many loans, is more important. Dollar liquidity matters more, so a corollary for our thinking is that the slope of Fed liquidity should be weighted more.
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