REVEALED: The Date When the Liquidity Starts Drying Up

We heaved up evidence last Wednesday that foreign central banks could be the true source of liquidity floating stocks to record heights.

While the Federal Reserve is goosing rates and preparing to tuck into its $4.5 trillion balance sheet…

Foreign central banks have flooded markets with a record $1.5 trillion of liquidity so far this year.

Bank of America terms it a “supernova of liquidity”… and the “flow that conquers all.”

But if stocks have risen on the cresting waters, atop the “flow that conquers all,” mustn’t they fall when the flooding recedes?

That is, when central banks start draining liquidity out the sluices… it seems stocks should wash away with it.

Ah, but when… when does the liquidity start draining away?

We have the all-important answer, revealed shortly…

A deluge of central bank liquidity post-2008 lifted the Dow from 7,000 in early 2009… to over 21,600 last week.

That is why, as Zero Hedge notes:

It is safe to say that the topic of the liquidity injection by central banks, or rather its removal, has become one of the most discussed topics within the financial community.

Citigroup reminds us that the market’s been at flood tide for nearly a decade — the combined balance sheets of the world’s main central banks haven’t contracted since 2008. Not for a minute.

But maybe not for much longer…

As we noted last Wednesday, the Federal Reserve intends to start draining its oceanic post-crisis balance sheet in September.

This, as word comes that foreign central bank asset purchases (which add liquidity to the financial system) are beginning to slacken.

For example, Bank of America’s top strategist, Michael Hartnett, notes that central bank asset purchases have fallen from $350 billion in April… to $300 billion in May… to less than $100 billion last month.

The Bank of Japan’s (BoJ) asset purchases in particular have fallen substantially in recent months.

Now our well-placed agents forward us unconfirmed rumors… salacious whispers… and snatches of overheard conversation indicating the European Central Bank (ECB) will begin tapering its asset purchases in September.

September, once again, happens to be when the Fed starts draining its own balance sheet.

So the “flow that conquers all” will soon slow to a trickle.

Declining central bank liquidity means the tide will eventually stop rising… level off… and finally recede.

But again, when?

At what point does the tide finally reverse?

The answer, coming by way of Credit Suisse’s Andrew Garthwaite:

The inflection in central bank balance sheets comes in Q3 2018.

Q3 2018… sometime between next July 1 and Sept. 30.

That’s when this Garthwaite fellow says:

The contraction in the Fed’s balance sheet… will start to exceed the purchase of assets by the ECB and BoJ…

“As Credit Suisse pointed out and as Citi confirms,” says Zero Hedge, “In roughly 12 months, the world is about to have its first period of aggregate central bank balance sheet contraction, even as the flow is already shrinking at a rapid pace.”

At that point, the tidal “flow that conquers all” will start receding… possibly dragging stocks out with the ebbing tide.

But the before-mentioned Michael Hartnett thinks a rout could start long before the tide rolls out Q3 next year…

Beware not the 12–18 months, says he… but the next three–four months.

He thinks peaking liquidity — twinned with peaking corporate profits — is leading right to peak market:

The most dangerous moment for markets will be when rising rates combine in three or four months’ time with an inflection point in corporate profits…

Big [market] top likely occurs when peak liquidity meets peak profits. We think that’s an autumn, not summer, story.

Then Harnett thinks investors will finally see what lies ahead in Q3 2018… and get out ahead of the tide… before it washes away their money.

Jim Rickards also turns his gaze to the shorter view…

Markets are complacent right now and are not expecting any sudden moves to the downside. But it’s when markets are most complacent that sudden drops are most likely… Another drop could be right around the corner.

Do we forecast a stock market collapse in Q3 2018… or within the next four months?

We shall not rise to that bait, dear reader.

We’ve been hooked too many times before by gaudy but false lures.

No, the answer is on the knees of the fickle gods, where it shall remain… until the gods themselves render their verdict.

But this much is certain: We’ll be keeping a watchful eye on the tides for the next several months.

You may want to as well.


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning