LIQUIDITY WATCH. Mr. HOENIG & THE CHALLENGE OF LIQUIDITY
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -32.7%]

Mr. Hoenig & the challenge of liquidity; the People's Bank of China & the ECB; booming Islamic finance.

[1] Mr. Hoenig & liquidity. Thomas M. Hoenig, the President and CEO of the Federal Reserve of Bank of Kansas City, was the lone dissenter at the October 30-31 meeting, when the FOMC voted to lower the target for the Fed funds rate by 25 bps to 4.5%. Yet, an interesting and overlooked piece of information emerges from the minutes: "He also recognized that liquidity remains a near-term challenge and that the Federal Reserve would be prepared to act if needed". This is where things get interesting. In a recent speech delivered in Sydney, Mr. Hoenig reveals himselft as a keen watcher of liquidity trends. To understand what is going on, he suggests, one needs to think within the framework of the (relatively) new "market-centered" financial system. In this context, it is not clear that the mere provision of liquidity to banks will solve all the problems, as was the case in the older "bank-centered" financial system.

"As a case in point", he adds, "the Federal Reserve's Discount window facility was not used as much as we might have liked in the recent crisis". In other words: policy-makers lack the appropiate knowledge about liquidity crisis in the new financial system — they will need to "focus more attention on research into the microstructure of financial markets to understand why liquidity crisis develop and why markets seize up in times of crisis". Very interesting, but where does that leave us in terms of Mr. Hoenig's vote at the next FOMC meeting? The following sentence says it all: "Until we have this understanding, we will be forced to deal with these pressures indirectly via the banking system" (italics mine). In other words: as market liquidity deteriorates even further, look for an unanimous vote at the next formal or informal FOMC meeting. [FOMC Minutes] [Thomas M. Hoenig: "Maintaining Stability in a Challenging Financial System: Some Lessons Relearned Again?", Kansas City Fed]

[2] The People's Bank of China & the ECB: diverging paths? According to Bank Credit Analyst, Chinese authorities will soon focus on the need to raise short term interest rates, rather than tightening reserve requirements: "Bank lending does not appear to be excessive and the root cause of China’s liquidity overflow is the massive accumulation of foreign reserves. In fact, the country’s low interest rates and ultra-weak currency are serious economic distortions. The risk of economic overheating will continue to build if China’s hyper-stimulative monetary environment is not reversed in a more timely manner". In a separate note, the Canadian consultants warn about excessively tight financial conditions in the eurozone: "the ECB might formally cut rates". [BCA Research: "China: More Tightening Needed"] [BCA Research: "The ECB Can’t Get Any Tighter"]

[3] Booming Islamic liquidity [Liquidity @ Financial Times]. Another day, another sukuk issuance. See the advertisement on page 17 of yesterday's Financial Times. JP Morgan is the sole bookrunner of a Sukuk structure with a forward setting exchange price. The amount: $1bn. The issuer: Dana Gas. The meaning: more diversity into the financial world — a bullish sign.