Central Bank Liquidity

Posted By Darren Winters on Jun 23, 2022

Central Bank Liquidity

If the direction of central bank liquidity influences asset prices, then it is central bank liquidity that also determines when cash is king and when cash is trash.

Famous billionaire hedge fund investor Ray Dalio often refers to cash as trash, but cash can also be king.

How often have you heard people lamenting being unable to participate in the bargains because they have no surplus spending money? 

So when money is tight, bargains are plentiful, and retailers try to spur buying by slashing prices. Financial market makers also slash asset prices to stimulate investors to buy.

Tight central bank liquidity conditions are a headwind on asset prices

Central Bank Liquidity

When liquidity is tight, money is scarce, and cash is king because it is the investor’s ammunition to go bargain hunting.

The goal of investing is to buy the low and sell the peak, which is easier said than done.


Central bank monetary policy influences the level of liquidity in the system and the trajectory of asset prices. Moreover, the transitions or pivots of monetary policy represent market tops and bottoms.

Central bank liquidity has been a significant factor determining asset prices since the financial crisis of 2008 for more than a decade

Some market watchers and economists would argue that the economy and the financial markets have been afloat on the central banks’ artificial life support of liquidity injections.

So the great recession and depression were prevented, perhaps temporarily, because of the greatest monetary easing experiment in the history of finance. The 2020 pandemic and global lockdowns resulted in a simultaneous blow-off top, in central bank liquidity and peak asset prices. 

Put simply, cash was trash during this period of unprecedented central bank liquidity injections

Monetary easing entailed record low-interest rates and trillions of dollars of asset purchases by the central bank, known as quantitative easing. 

But with inflation now at four-decade highs and central banks surrendering the transitory inflation narrative, monetary policy pivoted from peak liquidity in the final quarter of 2021 to tightening.

Tighter liquidity conditions in the second half of 2022 have resulted in worse performance for risk assets since the 1930s

Markets and the economy are on cliff edge, and the scary bit is peak hawkishness could still be off.

Chair Powell’s testifies to the Senate on June 22 confirms that the Fed thinks keeping aggregate demand down is good.

The Fed refuses to acknowledge that retailers are reporting inventory bloat, housing starts have crashed and US GDP in the first quarter contracted. 

But supply-side factors, the pandemic, and worsening war in Europe could add to inflationary pressures that the Fed admits it has no control over. 

So the Fed chooses to focus on inflation, further destroying demand in the economy with hawkish rate hikes and quantitative tightening. In other words, if central bank liquidity continues to tighten in a rapidly decelerating economy, standby for the crash of everything, as the bubble of everything bursts. 

Perhaps July GDP data, which could confirm the economy is in a recession, would make the Fed pivot to easing, and if so, there is your asset price support level. 

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