Global liquidity is drying up.
That’s the assessment of strategists at BNP Paribas led by William Marshall, head of U.S. rates strategy, who are looking not just at Federal Reserve balances but also what’s happening at the European Central Bank and Bank of Japan.
Most of that is stemming from Europe, where banks had to repay nearly €500 billion ($548 billion) of targeted longer-term refinancing operations, or TLTROs.
“The transition towards increased pressure on reserves in the U.S. from the middle of last month, coupled with TLTRO repayments in the eurozone have seen a sharp contraction in global excess liquidity in recent weeks,” said the strategists. “We think the continuation of this process at a minimum points to a more balanced (if not challenging) risk backdrop, and accordingly prefer a defensive approach to engaging with the FX carry theme.”
They noted popular longs including the Hungarian forint
USDHUF,
the Brazilian real
USDBRL,
and the Mexican peso
USDMXN,
have struggled of late. Over the last five days, the dollar has climbed 3% vs. the forint, 1% on the real and 0.3% on the peso.
The BNP strategists said not only are markets pricing in a “higher for longer” rate environment, but there are factors supporting a higher r-star this cycle than last. R-star is the real neutral rate of interest, and the subject of intense debate. The New York Fed’s estimate of r-star in the first quarter, by one model, was 1.14%.
“Continued (or resumed) momentum in economic data at a point where policy is seen as already restrictive should carry information that supports markets embracing that notion. Admittedly, the evidence has been somewhat mixed between regions, however, with signs of resilience more apparent in the U.S. (in labor market and service-related releases in particular) than in Europe. Nonetheless, in the absence of something ‘going wrong’, the path of least resistance may be to price current policy as de-facto less restrictive by resetting yields higher further out the curve,” they said.
Their conclusion is that either policy tightening is nearly enough and a more evident deterioration in the data is just around the corner, or even more restriction is needed. “Recent price action has seen a shift in this direction, with higher yields seemingly presenting a greater challenge to risk,” they said.
The benchmark 10-year Treasury
TMUBMUSD10Y,
rose 22 basis points last week.
The S&P 500
SPX,
dropped 1.2% last week, and has fallen two of the last three weeks.
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