Matt King, Founder of Satori Insights, LTD, discusses the impact of central bank liquidity on asset prices and market movements. He explores the correlation between global reserves and equity markets, emphasizing the importance of considering central bank activities globally. The podcast also explores the deviation between proposed quantitative tightening and actual easing by the Federal Reserve. Additionally, King discusses the robustness of the economy in the face of higher interest rates and potential risks of US government debt on the market.
Monitoring the financial plumbing, including Treasury and Central Bank-driven fund flows, is crucial in understanding liquidity dynamics and their impact on risk assets.
The additional liquidity injected by central banks in 2023 was the true driver of asset prices, overshadowing the tightening cycle and QT program.
Central bank liquidity and technical factors dominate market movements, explaining the dislocation between asset price performance and underlying fundamentals.
Deep dives
The influence of financial plumbing on liquidity dynamics
Since 2012, monitoring what's happening in the financial plumbing, where Treasury and Central Bank-driven fund flows can be responsible for powerful liquidity dynamics, has become crucial. Flows like quantitative easing (QE) and changes in the Treasury General Account (TGA) and Reverse Repo facilities significantly influence investor interaction with risk assets.
The resilience of the US consumer in 2023
The resilience of the US consumer and broader economy in 2023 was a surprise, considering the significant tightening cycle and the Federal Reserve's Quantitative Tightening (QT) program. However, the speaker argues that the true driver of asset prices in 2023 was the additional liquidity injected into the market, as central banks ended up providing about a trillion dollars' worth of liquidity, which boosted asset prices rather than draining reserves.
The impact of central bank balance sheet policies on asset prices
The speaker emphasizes the importance of understanding the impact of central bank balance sheet policies on asset prices. Central bank liquidity and technical factors, such as changes in reserves and the reverse repo program, have a stranglehold on markets. The dislocation between asset price performance and underlying fundamentals, such as credit spreads and defaults, can be explained by the dominant role of central bank liquidity and technicals in driving market movements.
The ongoing influence of central bank liquidity on market outlook
Looking ahead, the market outlook for risk assets in the next several months remains largely influenced by central bank liquidity. The short-term bullishness is supported by the ongoing effects of central bank balance sheet policies, such as increased reserves and a gradual reduction in quantitative tightening. The speaker notes that central banks are likely to remain cautious about reducing liquidity levels, underestimating their impact on asset prices and suggesting a continued favorable outlook for risk assets.
Concerns about asset price levels and vulnerability
While the current levels of asset prices, such as equities and credit spreads, appear to be inflated, the speaker raises concerns about their underlying fundamentals. The technical factors driven by central bank liquidity create a vulnerable market environment where investors are forced to be more bullish than justified by the fundamentals. Additionally, a distributional analysis reveals potential vulnerabilities in sectors with higher debt levels, as well as a broader overvaluation across assets. However, the ongoing support from central banks and the lack of an immediate bursting point suggest that vulnerabilities may not be realized in the near term.
Efforts to understand the “why” of the motion in asset prices consume our time and attention in markets. To be sure, traditional sources of risk – namely the economy, the path of corporate profits and changes in the interest rate cycle – do matter. But, as Matt King argues, especially since 2012, we increasingly need to monitor what’s happening in the financial plumbing where Treasury and Central Bank driven fund flows can be responsible for powerful liquidity dynamics.
Serving sometimes as a headwind and at others a tailwind, flows like QE as well as changes in the TGA and Reverse Repo facilities influence the manner in which investors interact with risk assets. After a nearly two decade stint at Citi, Matt recently founded Satori Insights, an independent firm helping institutional investors navigate today’s uneven and complicated waters of risk. A main aspect of our conversation is his take on the resilience of the US consumer and broader economy in 2023, set against one of the fastest tightening cycles on record and the Fed’s QT program. Matt’s work suggests that tying favorable asset price results in 2023 to this resilience leaves out a critical point.
He states that while the Fed’s balance sheet was nominally reduced by roughly a trillion last year, markets wound up enjoying a trillion in new liquidity. His framework, tying a trillion dollar increase in reserves to roughly a 10% increase in the equity market, helps explain the dislocation between asset price performance like tighter credit spreads and traditional fundamentals like defaults. Through the lens of liquidity that Matt utilizes, the risk asset outlook for 2024 is less favorable. He cautions that the Fed may have done more on the hiking front than they should have, underestimated the impact of their balance sheet policies on asset prices.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Matt King.
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