Shrinking Dollar LiquidityContracting USD liquidity supports a bullish US Dollar view and a risk-off positioning.
If the global Dollar liquidity fails to improve and continues to contract a deflationary environment may be ahead.
Certainly the USD indebted EM countries & corporations have already been heavily impacted by the rapid rise in the dollar.
Commodity indexes have shown this down turn for some time already and "Doctor Copper" is rapidly approaching a bear market.
The OECD composite leading indicator (CLI) has shown a significant down turn lately. It was designed to provide early signals of turning points typically 6-9 months ahead of the business cycle.
The DXY is rapidly approaching the 97 handle at this time. Short term this move may be overdone as the EURUSD has dropped beyond the expected move range for the month.
This 'dollar shortage' is caused by a slowing down of USD creation, as less USD is provided for the global financial system.
Monetary policy actions by the Fed continue to tighten and drain liquidity from the banking system :
1) QT is shrinking the balance sheet at a rate of soon to be 50 billion monthly
2) two more rate hikes of 0.25% are expected in 2018 on the overnight rate
At the same time as increased Treasury issuance:
Ballooning federal budget deficits means increased borrowing right at the same time as the Fed is cutting purchases.
Tax revenue is less than spending (Trump’s tax-cuts are part of the problem).
This is expected to boost the cost of credit, and likely ripple through the economy.
Anticipating such financial conditions ahead, many fund managers have already positioned portfolios defensively as markets proceed into a risk-off phase. The challenge is for managers & investors to identify ideal assets to navigate safely through a shrinking pool of liquidity. The end of this credit cycle will be no different to previous downturns.
