Citi: 'Quantitative Tightening' Is Real, and the Recent Market Selloff Proves Itby
A siphoning of the global liquidity punch bowl is fueling the 2016 downdraft in global equities, says Matt King, Citigroup Inc.'s head of credit product strategy, jumping on a thesis first promulgated by Deutsche Bank in September.
Individual stock markets aren't responding primarily to domestic liquidity conditions but rather to the state of monetary policy globally, King reasons.
Although direct economic linkages between emerging and developed markets are minuscule, in many cases, all equity markets have been affected by central bank stimulus—leaving them interconnected as the provision of liquidity becomes less ample.
After global stocks crumbled following the relatively small devaluation of the Chinese yuan in August, Deutsche Bank's George Saravelos floated the idea that sales of foreign exchange reserves by emerging-market central banks, particularly China's, were the driving force behind this turmoil.
Central banks in the developing world have divested some of their foreign exchange reserves in an attempt to prop up the value of their domestic currencies amid the carnage in commodity prices. This development, in theory, puts upward pressure on U.S. Treasury yields as central bankers sell the debt, effectively tightening global liquidity and weighing on risk assets.
Some, such as FT Alphaville's Matt Klein and Goldman Sachs's Zach Pandl, are skeptical of the claims made by Saravelos and expounded upon by his Deutsche Bank colleague Alan Ruskin. But for King, the proof's in the price action.
"Previous doubts as to whether such 'quantitative tightening' mattered for developed markets have unfortunately been addressed, at least in an empirical sense: the quality of the correlation speaks for itself," he wrote.
Emerging market central bankers are draining liquidity even as their peers in Europe and Japan are refilling the punch bowl, King observes, causing the pace of net purchases to decline considerably:
Spreads on junk-rated corporate bonds also closely track total central bank liquidity, according to Citi.
"The fact that global central bank liquidity correlates so well with market movements raises a number of awkward issues," the strategist writes. "Not only does it point to further downside if money continues to leave emerging markets," he says; it also may "suggest that [developed market] central banks are not fully masters of their own destiny."