With futures contracts tied to the price of water starting to trade last week, this seems a good time to take a look at the impact of liquidity. Liquidity means different things to different people, so before digging in, let me explain what I have in mind. For some, liquidity is the ability to transact a high volume at a low price or bid/offer spread. Others define it as the ease of converting an asset into cash.
The liquidity I’ll discuss here is what greases the wheels of financial transactions and usually emanates from central bank balance sheets. As these balance sheets expand, so does the supply of transactional currency – think of it as electronic money – relative to a given set of investment opportunities. As the supply of this currency increases, financing costs tend to decrease. As a result, the valuation of assets, and usually their prices, change.
How do central banks control the supply of reserves via their balance sheets? They can flood the system by purchasing securities in the open market, i.e., quantitative easing (QE), and drain it by selling them or more commonly letting them roll off without reinvesting. The need for liquidity with which to transact grows with the economy, so monitoring its supply becomes a dynamic process. Keeping tabs on it is also the starting point for an analysis of liquidity’s waterfall effect on broad asset classes. Read more…..
Chart of the Day
Jes Staley, Barclays CEO, joins ‘Closing Bell’ to discuss the IPO market, his outlook for banks and the firm’s investment bank strategy.