BoA On What’s Driving Financial Market Stress

Whither liquidity? It withers.

Bank of America Merrill Lynch has said that liquidity has been getting harder to come by in the wake of the Federal Reserve taking away the heady brew (for the markets) of monetary stimulus.

[bctt tweet=”Whither liquidity? It withers.”]

That absence, or at least recession, of stimulation has been partly to blame for the “stress” in financial markets, marked by volatility in the wake of “surprise revaluations” in currencies around the globe, notably in China, while Japan has introduced negative interest rates.

According to Bloomberg, BoA Head of U.S. Mortgages Chris Flanagan and BoA Strategist Mao Ding don’t throw shade only at monetary policy, but they do trace the stress level growing in the wake of the scaling back of seemingly open-ended asset purchases by the Fed beginning in 2014. They use as evidence Merrill Lynch’s Global Financial Stress Index. That index indicates risk levels, hedging demand and risk appetite and includes a liquidity subindex.

The analysts said that the stress level growth can be traced to new capital requirements for financial institutions and regulatory issues, which have a dampening effect on trading and balance sheet activity. Additionally, commodity prices have plummeted, which has roiled high-yield markets.

In their analysis, the analysts wrote: “The combination of these two factors has led to a somewhat vicious cycle and feedback loop, where poor liquidity is spreading and liquidity problems appear to be turning into fundamental problems. Moreover, tightening of monetary policy by the Fed, first through tapering and now through tightening, may have been necessary from an economic perspective, but the tightening appears to be adding fuel to the fire of liquidity deterioration.”

Solutions? Bloomberg noted that the analysts said that credit is really the only engine that can help restore liquidity, alongside a global policy response. Be wary of rising spreads.