Friday, July 6, 2007

. Federal Reserve: "Factors Affecting Reserve Balances", July 4

- Fed's Treasuries holdings: $785.5bn (+$8.1bn)
- Other central banks' Treasuries holdings: $1,240.7bn (+$9.0bn) (*)
- Other central banks' agency securities: $741.5bn (-$2.1bn) (*)
- Mackinlay's Global Dollar Liquidity Measure: $2,767.7bn (+$15.1bn)

(*) Off-balance-sheet items.

Another week, another sharp increase in our Global Dollar Liquidity measure. Central banks added more than $15bn to their collective balance sheets, thus contributing to the 15.5% annual rate of growth of funding liquidity — the highest since January 2005. To be sure, the quality of the increase leaves a lot to be desired: the Fed is the biggest contributor (reflecting, perhaps, a seasonal pattern). Note too, foreign CBs' unusual choice of Treasury securities over agency bonds — probably a consequence of higher yields.

Meanwhile, the "liquidity conundrum" is only intensifying, as market liquidity refuses to improve. Our Endogenous Liquidity Index is down 2.5%, reflecting higher credit spreads. In my view, a bullish solution to the conundrum is more likely than not. Inflation expectations continue to moderate, and global economic growth is as strong as ever (*). In the meantime, a trading range scenario should not come as a huge surprise to liquidity watchers.

(*) According to Geraud Charpin, head of European credit strategy at UBS quoted by the Financial Times's Alphaville blog, the sell-off in the CDS market is not being driven by fundamentals: "The sell-off in the market right now is purely technical: macroeconomic numbers have been pretty good and investors expect Q2 corporate earnings to be strong. Essentially, it's all about financial market deleveraging and adjustment rather than macroeconomic fears".

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