Wednesday, April 25, 2007


- On "dark" liquidity (*). Just when I thought I had heard enough about "endogenous, big, small, domestic, global, funding, and market" liquidity, I came across the notion of ... dark liquidity. Paul Temperton, director of the Financial Times Portfolio Academy, defines dark liquidity as "these pools of liquidity [that] will typically not be shown on conventional trading platforms provided by the stock exchanges or crossing networks". Dark liquidity, thus, belongs to the domain of "microeconomic" or "market" liquidity. Financial Times reporter Gillian Tett detects a recent "explosion of dark liquidity pools" in the United States.

The "darkest of dark liquidity", adds Tett, takes place inside investment banks' private networks. This "explosion" may well threaten the dominant position of stock exchanges worldwide. Investment Technology Group (ITG), for example, is marketing a trading platform aimed at improving "liquidity connectivity"; algorithms help to detect hidden sources of liquidity. Thus, hedge funds and other investors who, as Tett puts it, "like to stay in the shadows", can trade cheaper and without disturbing the share price.

(*) See Paul Temperton. "Trading with the help of guerrillas and snipers", Financial Times, March 19; Gillian Tett. "Equity investors show willing to come to the dark side", Financial Times, February 9; CASTrader. "The magic alpha of dark liquidity and partial diversity".

- The trouble with "domestic" liquidity. I sometimes mention the stock of Treasury securities held by the Fed (a proxy for the monetary base) as "domestic liquidity", as opposed to Treasury and agency securities held by foreign central banks ("global liquidity"). Strictly speaking, this is incorrect. Domestic liquidity can be influenced by global factors, and vice-versa. (Remember 1998). The key thing, in my mind, is to always consider them in tandem. This otherwise arcane issue came back to my mind as I watched a CNBC interview with David Sowerby, chief market strategist at Loomis Sayles.

According to Sowerby, the Federal Reserve will soon have to ease monetary policy in order to "improve growth rates in the monetary aggregates". Sowerby does have a point: the stock of Treasury securities held by the Fed is growing at a tepid 2.6% rate. However, IMHO, he misses the larger point: global dollar liquidity is booming (+19.8%). Overall liquidity conditions remain very robust. There is no need for the Fed to act.

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