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Analysis: Global liquidity swell to spill into 2014

A Wall Street sign is pictured outside the New York Stock Exchange in New York, October 28, 2013. REUTERS/Carlo Allegri
A Wall Street sign is pictured outside the New York Stock Exchange in New York, October 28, 2013. REUTERS/Carlo Allegri

By Mike Dolan

LONDON (Reuters) - After a bone-dry summer, world markets seem awash with cash again and it looks like spilling into 2014.

Even though the U.S. Federal Reserve has kept its $85 billion-a-month of bond buying constant throughout, fevered speculation surrounding its easy money spigot has by itself dictated the massive ebb and flow of liquidity seen this year.

The rethink of Fed intentions after September 18 - when the central bank declined to cut back its asset purchases as expected - has raised all financial boats in one big wave.

Since the Fed demurred six weeks ago, the S&P500 index of top Wall St stocks has jumped 3.5 percent. So too have 10-year U.S. Treasury bonds. High-yield corporate "junk" bonds are also up more than 3 percent, as are gold and the euro. Even indices of the most esoteric and speculative 'frontier markets' have added more than 3 percent.

The global surge has been remarkable as an evaporation of this year's U.S. dollar's gains has removed huge pressure from emerging market currencies and, in turn, eased the strain on some $7.2 trillion of emerging central bank reserves. And given these reserves are largely banked in western bonds, a virtuous circle of liquidity appears to have formed.

And by pumping up the euro and Japanese yen, the retreating dollar has upped chances of further easing - quantitative or otherwise - by the Bank of Japan and European Central Bank.

The global liquidity pool - one seeded by central banks and supercharged by the markets themselves - seems to expand anew.

Major stock markets from Tokyo, London, Frankfurt and New York have now clocked up year-to-date gains of between 20 and 30 percent and the latter two are in uncharted territory. Property hotspots in many of the same locales are similarly motoring.

Is this the mirror of the financial bubble that blew up pre-2007, as long-term bears such as Societe Generale's Albert Edwards insist it is?

With huge amounts of spare capacity still across developed labor markets and economies and little or no sign of rising inflation, policymakers seemed unperturbed.

But scale of money building up appears very real.

'MOST EXTREME EVER'

JPMorgan analysts reckon investor flows behind the latest market surge are akin to the indiscriminate, liquidity-fueled equity and bond buying seen at the start of the year before talk of Fed tapering saw an equity bias emerge as many funds fled bonds and the economy sped up.

More "Asset Reflation" than "Great Rotation" this time around, they surmise.

To be sure, U.S. Mutual fund data from Thomson Reuters' Lipper showed that last week alone there were hefty net inflows to equity, bond and money funds alike - more than $11 billion net to domestic equity, almost $5 billion to overseas equity and more than 3 billion to all taxable bond funds.

So what's the scale of this global sea of liquidity?

JPM splits the notion of liquidity into two buckets - one looks at how the banking system absorbs and distributes new QE money from central banks and another is the broad view of money supply in the wider economy of households, firms and investors.

The former can be febrile, as we saw during the summer.

When the central banks pump in new zero-yielding money, or excess reserves to the banking system, the banks just buy bills and bonds from other banks as the money gets passed around like a 'hot potato', bidding up asset prices and depressing yields.

That is until policy uncertainty lifts interest rate volatility and threatens bond prices, as it did after May, and forces those 'excess reserves' to go to ground and hunker down in cash again until the coast is clear.

With the Fed speaking softly again, one-month U.S. Treasury bond volatility indices <.MERMOVE> have fallen to their lowest since May - half of June's peaks.

On one level, it shows the power that policyspeak alone still has in controlling this money and many argue the stretch for yield during the first four months of the year prompted the Fed to deliberately fire its verbal shots across the bow.

The other measure of global liquidity, however, appears positively explosive.

JPMorgan estimates its measure of "excess liquidity" in the global system is still surging into record territory, with global M2 aggregates up by $3 trillion, or 4.6 percent, so far this year - far outstripping a 2 percent global inflation rate.

Two thirds of that M2 expansion came from emerging markets, where domestic loan growth shows few signs of being fazed by the mid-year financial market turbulence.

Using these "excess liquidity" gauges as a guide to asset prices and assessing their power over time, the report concludes that remains a powerful upsurge.

"The current episode of excess liquidity, which began in May 2012, appears to have been the most extreme ever in terms of magnitude," it concluded.

(Editing by Ron Askew)

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