Michael Howell: Liquidity Is Back

Episode Summary

Executive Summary: Michael Howell argues global liquidity bottomed in Oct. 2022 and is now turning up, driven mainly by the Fed’s effective liquidity support and aggressive PBOC easing. He expects a soft landing, range-bound major markets, stronger EM/China, firmer commodities, and eventual policy support that favors equities, credit, real assets, gold, and crypto over long-duration government bonds.

Main Topics: Global liquidity cycle bottoming and turning up (Priority: 5/5): Howell says his global liquidity index, covering about 90 central banks and private-sector creators, bottomed in October 2022 and is now inflecting higher, consistent with a normal 6-7 year liquidity cycle. Federal Reserve balance sheet vs. effective liquidity (Priority: 5/5): He argues the Fed can shrink its balance sheet while keeping effective liquidity flat or rising via changes in reserves, reverse repos, and the Treasury General Account, implying a separation between inflation control and financial-stability policy. China as the main global liquidity accelerator (Priority: 5/5): The PBOC has sharply increased liquidity injections after easing yuan pressure and reopening post-COVID, which Howell sees as a major support for Chinese assets, commodities, and global growth momentum. Bond market volatility, collateral, and yield curve control (Priority: 4/5): Lower bond volatility reduces collateral stress and repo constraints. Howell believes central banks are increasingly focused on stabilizing sovereign debt markets, which may amount to an emerging form of yield curve control. Market outlook: soft landing, range-bound markets, selective winners (Priority: 4/5): He expects major stock and bond markets to trade sideways overall in 2023, with opportunities in EM, China, cyclicals, commodities, corporate credit, and monetary hedges rather than broad beta everywhere. Yield curve inversion and term premium distortion (Priority: 4/5): Howell says the inverted yield curve is a real warning but overstated because deeply negative term premium reflects collateral scarcity and demand for Treasuries, so the curve signals financial fragility more than a severe recession. Cross-border flows and private-sector liquidity (Priority: 3/5): He describes a shift away from persistent U.S. inflows toward emerging markets, while private-sector liquidity is mixed: bank lending is picking up, corporate cash flow is fading, and shadow banking is more sensitive to dollar weakness and lower volatility.

Key Arguments: Liquidity, not rates alone, is the main driver of asset prices because the financial system is primarily a refinancing machine. The global liquidity cycle bottomed in October 2022 and should rise through 2023-2024, consistent with the normal six-to-seven-year cycle. The Fed can reduce its balance sheet while effectively supporting market liquidity through TGA, reverse repo changes, and other liability-side adjustments. The Fed’s liquidity actions are best understood as financial-stability management after the gilt crisis, while rate hikes remain the main anti-inflation tool. Bond market volatility matters more than equity volatility for liquidity because it affects collateral, repo financing, margin calls, and funding conditions. China’s easing is unusually powerful and likely to lift commodities, Chinese equities, and global earnings momentum. The yield curve’s recession signal is distorted by negative term premium, so it is a weaker guide to the depth of any coming downturn. Markets in 2023 are likely to be range-bound overall, but selective areas can outperform: emerging markets, China, commodities, cyclicals, credit, gold, and crypto. The U.S. banking system appears strong due to heavy regulation, while European banking remains structurally challenged by the euro-area design. High rates are survivable, but the bigger constraint is the need to refinance a huge debt stock without letting sovereign yields rise too much, pointing toward eventual yield curve control.

Data Points: Global liquidity index bottom: October 2022 - Howell says his global liquidity index inflected higher from this low point. Liquidity cycle length: 6-7 years - He says this is the typical duration of the liquidity cycle. Fed balance sheet size: $8.4 trillion - Referenced as the Fed balance sheet level while discussing QT and effective liquidity. Fed QT roll-off pace: $80 billion/month to $95 billion/month - Discussed as the approximate pace of balance-sheet reduction. U.S. bank reserves: About $3 trillion - Compared against the reserve threshold needed for market functioning. Reserve threshold estimate: $1.9 trillion to $2.6 trillion (with a cited lower bound near $2.5 trillion) - Discussed as the minimum safe level for the financial system. Reverse repo facility: About $2.4 trillion - Howell says this pot can shrink significantly and free up liquidity. PBOC liquidity injections: 3 trillion yuan (~$450 billion) in Dec. and Jan. - He says China injected more liquidity in two months than in the prior two years. Chinese liquidity relative to prior years: About 3.5x the total injected in the prior two years - Used to emphasize how aggressive the PBOC has been. U.S. Treasury market liquidity index: Below 10 during the gilt crisis; above 50 now - Shows how market liquidity worsened around the U.K. gilt episode and then recovered. U.K. gilt crisis date: September 2022 - Used as the inflection point for Treasury market liquidity stress. US 10-year Treasury term premium: Most negative in almost 60 years - Howell cites the New York Fed ACM calculation as evidence of collateral scarcity. Global debt stock: Around $300 trillion - He uses this to argue the system is more about refinancing than new financing. Annual debt refinancing need: $60-$65 trillion per year - Derived from the debt stock and average debt maturity of about five years. Chinese reserve injections into markets: $450 billion - Converted estimate of the 3 trillion yuan PBOC injections.

Pivotal Quotes: "Liquidity bottomed. On our calculations, that index bottomed in October of 2022. It's beginning to inflect upwards." — Michael Howell: Core thesis on the turning point in global liquidity. "The Federal Reserve may be able to have its cake and eat it here." — Michael Howell: His explanation that the Fed can shrink its balance sheet while maintaining effective liquidity. "The PE is made in America... and the E is made in China." — Michael Howell: His shorthand for how Fed liquidity and Chinese stimulus jointly drive equity valuations and earnings.

Implications: If Howell is right, the next phase favors China, emerging markets, commodities, and credit over long-duration government bonds. Investors should watch bond volatility, reverse repo runoff, and PBOC stimulus as the key signals for risk appetite.