Global Liquidity Update: Low margin of safety for equities, volatility biased higher

Our key liquidity indicators have worsened since the start of the year and suggest volatility is biased higher from here.

Liquidity is the main negative drag on our VP Macro Risk indicator, which overall remains in a “neutral” regime. The low volatility in equity markets is at odds with this backdrop of negative liquidity and a neutral risk indicator. 

A bias for higher volatility makes sense given the leading relationships our three key liquidity indicators have with equity prices. Today, two of the three indicators suggest liquidity will be a headwind for equities this year.

First, our Mehrling Multiplier indicator has continued to fall to cycle lows, implying less “margin of safety” embedded in liquidity to support asset prices.

Second, our Global Excess Liquidity indicator is now firmly in negative territory after briefly turning positive at the turn of the year.

Finally, and by contrast, our diffusion index of central bank activity - the VP BCFI  - shows the breadth of easing cycles is supportive of continued equity gains.

That said, sticky (or even rising) inflation has been a common theme in most economies and in some places is holding back policymakers from further rate cuts (e.g., sticky UK inflation and the BoE). We'll be monitoring the BCFI to see if this liquidity tailwind from central bank cuts will fade. 

Taken together, these indicators suggest overall liquidity is a headwind for asset prices. We reaffirm our call to selectively add long volatility exposure, consistent with our leading indicator for volatility pointing higher.

See our Liquidity and Volatility chart collections for our complete set of charts on these topics.