Tracking Global Liquidity Pools to Guide Investment Decisions

  • 15th, October, 2019
Tracking Global Liquidity Pools to Guide Investment Decisions

Tracking Global Liquidity Flows to Guide Investment Decisions

 Global liquidity flows amount to hundreds of billions of dollars every month and these flows have huge impact on investment returns and on investors’ strategies. But how should we make sense of the vast sums involved and, more importantly, how can we exploit them in our own financial strategies?

Arab Banker spoke to Michael Howell, whose firm Cross Border Capital produces a range of Global Liquidity Indexes. We asked him to explain the factors that drive global liquidity flows, and what movements in liquidity can tell us about broader economic trends.


Arab Banker:  What are the components that make up global flows of liquidity?

Michael Howell: There are three elements of global liquidity flows. The first is liquidity created by central banks as part of their monetary operations. This has been in the news a lot in recent years as a result of the ‘Quantitative Easing’ strategies pursued by the US and European central banks, but there are also hundreds of billions of dollars (or dollar equivalents) that are created through routine monetary operations as central banks try to manage indicators such as inflation and interest rates.

The second element is domestic private sector flows, which are created through personal bank deposits and savings, bank lending, and credit created by ‘shadow banks’ – institutions that perform deposit and credit functions, but which are not licensed as banks.

The third element is cross border inflows such as the purchases of domestic stocks and bonds by foreigners, and, say, US dollar borrowing by domestic banks from offshore markets. 

Where are the biggest pools of global liquidity?

China now contributes most to the global pool of liquidity. Globally, there is about $130 tn in liquidity, and China accounts for about US$35 trillion of this, a little more than the US, which accounts for about $29 tn – although the dollar ‘punches above its weight’ in influencing global liquidity flows as a result of its role as the key global reserve currency and the role that is played by the US Federal Reserve Bank. 

The next biggest pool of liquidity comes from the Eurozone – about $28.5 tn, and then Japan, with about $10 tn. 

The table at the bottom of the page shows the relative size of liquidity worldwide. 

How are global liquidity flows correlated with economic activity? 

There’s a strong positive correlation between increases in liquidity flows and growth in economic activity. For example, if you track cross border flows and world shipping activity, you’ll see a strong relationship – as liquidity increases, so does shipping activity.  It is not surprising that as liquidity increases, macro-economic growth accelerates, but what we can see is that liquidity is a leading indicator – expansion or contraction of global liquidity typically leads real economic activity by 12 – 15 months. We can use this not only to advise clients on investment decisions but also to help them take positions on interest rates and currencies. 

How do you quantify changes in global liquidity? 

We use an index to that is based on macro-economic liquidity conditions in 80 economies. On our scale of 0 – 100, a reading above 50 indicates an expansion of liquidity, while a reading below 50 indicates a contraction. 

The chart attached below shows how global liquidity has risen or fallen, on our scale of 0 - 100 over the last 50 years, reflecting major economic and financial events, such as financial crises and central bank actions. 

For example, we’ve recently seen an unusually large divergence between total global liquidity and the US Treasury 10-2 yield curve, implying that the yield curve should rise significantly in the near future.

What trends are you seeing right now? 

The US Federal Reserve is leading a fourth round of Quantitative Easing. We are also noticing that money is flowing internationally away from China and China-related markets into the US. Meanwhile, the UK is displaying no signs of Brexit-related outflows – the biggest issue for the UK is that the Bank of England is not contributing much to global liquidity movements right now. 

In the Middle East, inflows of money to Saudi Arabia are weakening and liquidity in the Kingdom is highly dependent on actions by the Saudi Arabian Monetary Agency. The general trend recently has been to see international liquidity flowing out of Saudi Arabia, the UAE and Qatar. 

Something that we are keeping an eye on right now is the sharp divergence between China-related flows – where we are seeing money leaving – and the US and Eurozone, where money is flowing in. This divergence is unusual. 

What is global liquidity telling you about how investors should position themselves? 

Putting everything together, we are advising clients to reduce holdings of bonds and to increase exposure to the US dollar and to gold. More generally, we are advising them to increase holdings of developed market stocks and not to add exposure in emerging markets. 


Michael Howell founded CrossBorder Capital in 2004 after a heading research departments at Salomon Brothers and Barings securities. The firm is based in London and provides investment advisory services and macro research, as well as asset management services.


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