BoJ / ECB liquidity boost lifts markets
Simon Ward
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Equities and other risk assets have been sensitive to shifts in central bank liquidity since the dramatic easing that followed Lehman’s collapse in September 2008. A post in early June noted that combined bank reserves at the Fed, Bank of Japan and ECB were edging higher again, implying increased support for markets.
The rise has since continued, resulting in G3 reserves reaching a new record high and helping to explain this week’s strong equity rally – see first chart. Unexpectedly, the recent increase is the result of stepped-up liquidity provision by the BoJ and ECB rather than the tail-end of QE2 in the US. The Japanese infusion may have been a response to yen strength and has succeeded, at least for now, in capping upward pressure on the currency – second chart.
The rise in ECB reserves is a reflection of a recent increase in demand for funds at the weekly refinancing operations as funding for weaker banks has dried up in response to the latest Greek crisis.
US reserves remain below their mid June level despite further QE2 operations because the Treasury has increased its cash balance at the Fed, possibly as a precautionary measure in case negotiations over raising the debt ceiling fail. The balance in the Treasury’s general account rose from $23 billion to $106 billion between 8 and 29 June. Reserves should move above the prior high as this cash is released back into the system over coming weeks.
Barring a surprise reversal of the recent BoJ and ECB injections, therefore, central bank liquidity will remain a near-term support for markets.
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