There Is Still Plenty Of Punch Left In The Punch Bowl (For The Moment)

So, you may be wondering: why is it that volatility (which spiked last Wednesday) is so quick to drop back to it's lower levels in spite of all the uncertainty surrounding the global financial markets and the Trump administration?

The simple answer is liquidity (and the perception of liquidity). Which is all controlled by the central banks.

What is scary about liquidity is that once the central banks decide to reduce liquidity (pull the proverbial punch bowl away from the party) the reality of the next era for financial markets may be not so pretty (or fun).

Those that have been using the down days to add to equity positions will be using the up days to lighten up.

So the reality of the "Trump" trade (as it has been so nick-named) is really a function of the continued "easy" monetary policy at the US Federal Reserve, despite their continued threats to raise interest rates (warning shots) on multiple occasions over the course of this year and into next year.

However, until all the other central banks: European Central Bank (ECB), Bank of Japan (BOJ), Bank of England (BOE) and Bank of Canada (BOC) all decide to join in to tighten monetary policy, there will continue to be plenty of liquidity available.

The enormous risk in the financial markets is the very inelastic follow-through that could occur when liquidity is curtailed (global monetary policy tightened) because all asset classes (save for cash) will become correlated and the selling could be significant.

All central banks have a mandate to create price stability (keep inflation at or near a 2% target). Thus far (except in the UK, because of the post-Brexit depreciation of the Pound), inflation has remained subdued. It is widely expected to pick up (especially in the US) as economic growth picks up. So mounting pressure will come to bear on the central bankers.

As a case in point: in the world's second largest economy, China,  monetary policy tightening (draining of liquidity) to counter the enormous growth of debt in that country has had its impact: slowing economic growth in April and sending the Shanghai Composite down some 7%.

The party is alive as long as the punch bowl remains. When it is removed, everyone will be heading for the exits (all of them) in a hurry.

We will talk about this and lots of other influencing factors for the decisions that we make in the management of our and our client's money on our weekly webinar today. You can tune in to the recorded version, at or about 5pm EDT today.

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