Thursday, June 7, 2007

. Federal Reserve: "Factors Affecting Reserve Balances", June 6

- Fed's Treasuries holdings: $785.6bn (+2.3bn)
- Other central banks' Treasuries holdings: $1,229.9bn (-$1.5bn) (*)
- Other central banks' agency securities: $725.5bn (-$2.4bn) (*)
- Mackinlay's Global Dollar Liquidity Measure: $2,741.1bn (-$1.6bn)

(*) Off-balance-sheet items.

Testing times for liquidity bulls! The latest Fed balance sheet contains lots of (potentially) useful information. First things first: there is a weekly contraction in our Global Dollar Liquidity measure. OK, it's only a tiny one (-$1.6bn), but as Bill Gross said in a interview that set the tone for Thursday's bond market rout, what counts is what happens ... at the margin! Foreign central banks sold about $4bn in treasuries and agencies. "We're not talking about a major overnight shift but at the margin", said Gross. We'll see.

Note the positive contribution of "domestic" liquidity. This may reflect the changing shape of the yield curve, which is getting steeper day by day. (Bank reserves at the Fed are at a five-month high). Last but not least, our Endogenous Liquidity Index has fallen sharply, losing 8% in just two days, courtesy of the surging VIX and of rising CDS spreads. There you have it. The only thing that can be said in favor of liquidity bulls is that the Global Dollar Liquidity measure is growing at a (preliminary) 14.5% annual rate, the fastest pace since February 2005. Will it be enough to keep the equity bull market running? As Ronald Reagan famously said: "Trust, but verify".


F. said...

How likely is it that the Fed is currently running a repo operation to combat yesterday's record VIX spike?

Agustin said...

F, the Fed is watching everything, including the VIX. It gives them useful information about how markets perceive volatility. But it's not their job to try and combat a spike in the VIX. Regards, Agustin.