Global liquidity to tighten

Important Information

We want to make investing with us simple and straightforward for all of our clients.

Please select your investor type from the options below.

Alternatively you can register or log in to an existing account.

Please note that by making your selection here you are agreeing to the Woodford Investment Management Ltd Privacy Statement and to our Terms and Conditions.

“We are at a crossroads for extraordinary monetary policy. Much is misunderstood about the original purpose of QE, what impact it has had, and in turn, what impact its withdrawal is likely to have. These misperceptions exist right at the heart of our central banks, hence the risk of a major policy error cannot be ignored.”

– Neil Woodford

In this inter-connected, globalised economy, dollar liquidity is key. Its importance as the grease in the wheels of the global financial system is easily under-estimated. In simplistic terms, when dollar liquidity is abundant, global trade tends to be strong, the dollar is typically weak, commodity prices rise and equity markets do well. In the post-financial-crisis world, these relationships seem to have become more pronounced. But when dollar liquidity tightens, all of these things go into reverse.

We believe that liquidity conditions in the global financial system have started to contract and that this is likely to gather pace in the second half of the year. The primary reason for this is that central banks, led by the Federal Reserve (Fed), are now tightening policy.

The Fed has already increased interest rates twice this year (in March and in June, both times by a quarter of a percent) and, if its dot plots are to be believed, we should expect another two 0.25% interest rate increases this year. Meanwhile, its quantitative tightening (QT) programme will cause global liquidity conditions to deteriorate further. On current plans, by the end of the fourth quarter in 2018, QT will be draining an annualised $600bn from the financial system, exerting deflationary pressures on the US economy, with huge potential implications for global financial markets and the world economy.

We are already seeing the consequences of tighter liquidity conditions, most acutely in emerging markets, with steep declines in many South American and Asian stock markets and increasing signs of tension in foreign exchange markets. Although financial markets in the developed world have so far been resilient to this development, the deterioration in global liquidity conditions will inevitably have an impact in the months ahead.

Financial Times

A stronger dollar means a lot more emerging market stress

The potential for trouble has been illustrated by the pressure on Argentina

9 May, 2018 John Authers

FT Logo
Close

A stronger dollar means a lot more emerging market stress

The potential for trouble has been illustrated by the pressure on Argentina

The geopolitical outlook is, to use a word that has forced its way to the top of the political vocabulary this year, stormy.

But while the storms and risks are evident and appear to blow in different directions, they are in fact beginning to blow in one direction. Numerous pressures are pushing the dollar upwards, and exacerbating a global problem with the shortage of dollars.

The potential for trouble has been illustrated by the stress for Argentina — which has now followed raising interest rates by 10 percentage points in a week by asking for help from the International Monetary Fund — and Turkey. Both are emerging markets with specific and serious local issues, and a growing proportion of their debts denominated in dollars. But the problems could be far more widespread if the advance of the dollar continues, and they would not be limited to emerging markets.

The forces upwards on the dollar include the rise in crude oil prices, which is continuing following the US decision to leave Iranian nuclear agreement; resurgent political risk in Italy, which weakens the euro; higher short-term rates and quantitative tightening from the Federal Reserve that reduces dollar liquidity and increases the appeal of the dollar to foreign investors.

For both two-year and 10-year bonds, the yield differential of US over German bonds reached another high for the euro era on Wednesday. The 10-year Treasury yield took another trip above 3 per cent in Wednesday trade so the risk of a secular upswing remains real in the minds of traders.

The ugly trade negotiations with China, in which the US appears to many to be deliberately provoking a trade war, add to uncertainty and to upward pressure on the dollar.

The combination of dollar strength, tightening US financial conditions and political uncertainty has a well-established corollary: emerging markets weakness. That creates serious problems for the affected markets in the short term, including the risk of crisis if they cannot repay their debts. It also creates opportunities in the slightly longer term as emerging markets investments still tend to be indiscriminate, with flows entering and leaving “EM” as if is one coherent bloc, even though the differences in balance sheet management between different countries are growing ever wider.

Emerging markets government bonds, measured by JPMorgan’s EMBI index, are at their lowest since February 2016, when the world was in a scare over Chinese devaluation. The index has slid by 8.3 per cent since January.

Meanwhile, emerging market foreign exchange, also as measured by JPMorgan, is weaker than it was on election day, and close to its lows from the days after the election when an emerging market crisis appeared a real risk:

Emerging markets’ data have been disappointing of late, after a brief period earlier this year when they seemed to join a co-ordinated global recovery. The Citi emerging markets economic surprise index has turned slightly negative.

But the greatest issue is the stormy weather emanating from the US. As Jorge Mariscal, emerging markets chief investment officer at UBS Global Wealth Management, puts it: “The question is how the markets will interpret this sugar rush of fiscal stimulus that Mr Trump has injected. Will technology offset the inflationary pressure?”

He doubted that this would cause a generalised emerging markets issue, as there has as yet been no sign of contagion in Asia. He added: “Argentina and Turkey are vulnerable because their balance sheets are very exposed to the US dollar. Any sign that global liquidity is tightening is a problem. The bottom line, to quote Warren Buffett, is that when the tide flows back you can see who is swimming naked. The tide is pulling back and it’s revealing the countries with problems that were overlooked when liquidity was abundant.”

Should risk sentiment recover, there should be opportunities to buy emerging markets credits that have sold off unduly — Colm McDonagh, head of emerging market fixed income at Insight Investment, suggests the greatest opportunities are in the Middle East, Latin America and Asia, and also in the growing local currency debt markets.

But it is important to note that a dollar shortage does not merely affect emerging markets. According to the IMF’s latest Global Financial Stability Report, published last month, many non-US banks are reliant on dollar funding, particularly in Japan. Canada is also heavily reliant on US dollar funding. That means, as the IMF put it, that banks could “act as an amplifier of market strains” if they are compelled to sell assets into a turbulent market.

Mr Trump was elected to change the status quo, and he is doing so. The question is whether the stormy weather creates such a dollar shortage that other markets around the world cannot cope.

Copyright The Financial Times Limited 2018

© 2018 The Financial Times Ltd. All rights reserved. Please do not copy and paste FT articles and redistribute by email or post to the web.

Source: ft.com

Neil's view

As the era of easy money draws to a close, with the Federal Reserve intent on steadily shrinking the size of its substantial balance sheet, the implications for global liquidity and the US dollar pose a hazard for financial markets that have been paying too little attention to risk.21 December 2017

Ten years on from the global financial crisis, we are witnessing the product of the biggest monetary policy experiment in history. Investors have forgotten about risk and this is playing out in inflated asset prices and inflated valuations. Whether it’s Bitcoin going through $10,000, European junk bonds yielding less than US Treasuries, historic low levels of volatility or smart beta ETFs attracting gigantic inflows – there are so many lights flashing red that I am losing count.1 December 2017

Signs of liquidity stress appearing in interbank lending market?

Source: Bloomberg, Woodford

The LIBOR-OIS spread is seen as a measure of financial stress within the banking system - a widening spread suggests that interbank funding costs are rising relative to the risk free-rate. As the chart illustrates, there has been a very specific rise in dollar funding costs recently, which is indicative of diminishing dollar liquidity, globally.

Global liquidity conditions have tightened aggressively - and are likely to worsen

Source: MacroStrategy, Woodford

Global liquidity expected to continue tighteningQE 1QE 2QE 3% change20102012201420162018200920112013201520172019Excess global US$ money supply (6m annualised)-20-15-10-505101520 ? Fed tapers China bank bailout Yellen talks down the US$ Debt ceiling raised

Chinese money supply growth already slowing

Source: Bloomberg, Woodford

Implied path of future US interest rates

Source: Bloomberg, Woodford

How the funds will benefit

As well as the Fed’s tightening of monetary policy, we also have the reduction of the European Central Bank’s (ECB) extraordinary monetary policy to contend with. In combination, we believe the impact of this deterioration in global liquidity conditions will act as a brake on economic growth and on financial asset prices around the world, with very few regions looking capable of escaping the fallout. With equity markets pricing in perfection for the global economy, this will come as a shock to a complacent consensus.

There is one developed economy, however, whose money supply growth outlook is not facing the impact of the withdrawal of extraordinary monetary policy. The UK economy has sustained nominal broad money supply growth of around 5% per annum recently – this, coupled with all the other positive trends in the UK economy that we have been highlighting, is enough to suggest that domestic growth can accelerate in the months ahead, leaving consensus expectations looking far too low.

Our contrarian strategy has actively avoided areas of the market that look most vulnerable to the withdrawal of liquidity, focusing instead on stocks, particularly domestically-focused companies here in the UK, that have not benefited from abundant liquidity. As always, valuation guides this disciplined investment approach.

LF Woodford Equity Income Fund (as at 30 September 2018)

Geographical allocation
Country Fund (%)
United Kingdom 88.38
United States 9.78
Norway 1.77
Ireland 0.66
Switzerland 0.55
Luxembourg 0.40
Sector allocation
Industry Fund (%) Benchmark (%)
Financials 34.31 25.73
Health Care 22.46 9.11
Consumer Goods 22.27 14.30
Industrials 15.95 11.32
Technology 4.94 0.88
Consumer Services 1.56 11.62
Basic Materials 0.05 7.66
Telecommunications 0.00 2.95
Oil & Gas 0.00 13.91
Utilities 0.00 2.52
Cash and near cash -1.54 0.00
Total 100.00 100.00

What are the risks?

  • The value of investments and any income from them may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The annual management charge applicable to the funds is charged to capital, so the income of the funds may be higher but capital growth may be restricted or capital may be eroded
  • The funds may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits
  • The funds may invest in overseas securities and be exposed to currencies other than pound sterling
  • The LF Woodford Income Focus Fund will be invested in a concentrated portfolio of securities – the fund is not restricted by reference to any geographical region, sector or market capitalisation
  • The LF Woodford Equity Income Fund may invest in unquoted securities, which may be less liquid and more difficult to realise than publicly traded securities

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund – or Key Information Document (KID) for the trust – and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

You should note that capital is at risk with these investments and you may get back less than you invested. The value of the fund or trust as well as any income paid will fluctuate which may partly be the result of exchange rate changes.

The price of shares in the Woodford Patient Capital Trust is determined by market supply and demand, and this may be different to the net asset value of the trust.

The Woodford Patient Capital Trust currently intends to conduct its affairs so that its securities can be recommended by IFAs to ordinary retail investors in accordance with the FCA’s rules in relation to non-mainstream investment products and intends to continue to do so for the foreseeable future. The securities are excluded from the FCA’s restrictions which apply to non-mainstream investment products because they are shares in an investment trust.

Young businesses have a different risk profile to mature blue-chip companies – risks are much more stock-specific, which implies a lower correlation with equity markets and the wider economy. Long-term outcomes are more binary – extremely attractive rewards for success but some businesses will inevitably fail to fulfil their potential and this may expose Woodford Patient Capital Trust investors to the risk of capital losses. As it can take years for young businesses to fulfil their potential, this investment requires patience.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund’s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

© 2018 Woodford Investment Management Ltd.
All rights reserved.

Are you sure?

By disagreeing you will no longer have access to our site and will be logged out.

Privacy Preference Center

Experience Tracking

Lets our analytics service track you across our different websites and enables data sharing among our different marketing tools.

AMCV_[Tracker ID]@AdobeOrg (Adobe), [Tracker ID]@AdobeOrg (Adobe)
Adobe Analytics (helps us provide you with more relevant experiences and content based on your likely interests). Cookies: demdex, dextp, dpm, DST, DSTJS
Twitter personalisation (by better understanding how devices are related, Twitter can use information from one device to help personalize the Twitter experience on another device). Cookies: personalization_id
Heap Analytics (provides metrics on user behaviour and actions throughout the site). Cookies: _gid, _hp2_id.[Tracker ID],_hp2_props.[Tracker ID], _ga, _mkto_trk, optimizelyBuckets, optimizelyEndUserId, optimizelySegments, raygun4js-userid, _attribution_referrer, _csrf
Adobe Analytics (provides you with more relevant experiences and marketing messages based on your likely interests). Cookies: _tmae ,ev_sync_dd,ev_sync_yh,everest_g_v2,gglck

Traffic Metrics

Allows Woodford to aggregate information on website usage and popular content

_ga, _gid
Google Analytics (tracks and reports website traffic and user behaviour): Cookie: CONSENT
New Relic (application and server performance monitoring – allows us to spot problems with our website code and improve them to keep things running smoothly). Cookie: JSESSIONID
Adobe Analytics (provides you with more relevant experiences and marketing messages based on your likely interests). Cookies: __qca,__smToken, _ga, _mkto_trk, _rtbmedia

Search History

Populates the 'recent searches' section of the website navigation.

wf__recent_searches_untracked

Close your account?

Your account will be closed and all data will be permanently deleted and cannot be recovered. Are you sure?