Global Liquidity Tightens: China's Role and Market Implications

Summary

Global liquidity conditions are tightening, a shift driven by a strong real economy, particularly in the US, pulling money away from financial assets. This transition is impacting liquidity-sensitive assets like gold and cryptocurrencies first, acting as an early warning. Equity markets typically lag these liquidity movements by about nine months, while bond markets respond within six months, and precious metals and crypto within three months. The real economy is expected to feel the effects 15-18 months later. Despite rising inflation, the US faces a dilemma: raising interest rates to curb it could swell its large deficit and debt. Authorities are actively intervening to suppress bond yields and volatility, with the US Treasury buying back debt and the Federal Reserve injecting liquidity. Stock markets, especially in tech and emerging markets, are showing signs of a bubble, characterized by concentrated gains. Globally, liquidity flows are turning downward, coinciding with a strong world business cycle, meaning money is moving from financial markets to the real economy. Central banks are just beginning to tighten, not aggressively leading the process. China's central bank has abruptly slowed liquidity injections, impacting the yuan gold price, potentially as a tacit agreement with the US to curb oil use amidst Iran tensions. Looking ahead, the gold-oil ratio historically averages 20:1, suggesting a medium-term oil price target of $200 a barrel if gold reaches $4,000 an ounce. In terms of asset allocation, with liquidity turning down, a defensive portfolio with more cash and less exposure to riskier assets like equities is advised, potentially shifting towards longer-dated government bonds as the commodity environment deteriorates.