Quantitative & Derivatives Strategy
Flows & Liquidity : Financial conditions impulse remains positive
May 8, 2024
Flows & Liquidity : Financial conditions impulse remains positive
Flows & Liquidity : Financial conditions impulse remains positive
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08 May 2024

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Flows & Liquidity

Financial conditions impulse remains positive

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  • Our proxy for the financial conditions impulse remains positive, posing some upside risks for growth and inflation.
  • The PBoC has been more contrarian than other central banks in terms of gold purchases.
  • SEC’ Wells notice to Robinhood should not pose an obstacle to an eventual spot ethereum ETF approval.

  • After the release this week of the Fed’s senior loan officer survey, along with the ECB’s bank lending survey that was released a few weeks ago, financial conditions have again featured in our conversations. After the significant decline in respondents reporting a tightening in lending standards in both the US and the Euro area in the 1Q24 surveys, the latest survey suggested a modest tightening for the US in 2Q and a continued modest decline to close to zero for the euro area.

Figure 1: Net percentage of banks reporting tightening standards for US C&I loans to large and middle-market firms and Euro area loans to all enterprises

In %.

Source: Federal Reserve, ECB, J.P. Morgan.

  • What about financial conditions more broadly? In order to look at this, we update the financial conditions framework (see e.g. F&L, Sep 2016) built on a paper by Kasman and Mackie, Aug 2008, on quantifying the impact of financial market developments and monetary policy actions on economic activity. They drew on a methodology described in the IMF paper “A US financial conditions index: putting credit where credit is due” by A. Swiston, who estimated the impact of changes in six financial variables on the level of GDP after one to two years. The six financial variables are: 12-month changes in the 3-month short rate, the yield on investment grade corporate bonds, and the spread of high yield corporates over that of high grade, as well as 12-month real equity returns and the 12-month change in the real FX rate and bank lending standards for businesses as reported in loan officer surveys.
  • This financial conditions indicator is depicted in Figure 2 for the US and the Euro area. It shows that financial conditions steadily improved from their peak tightening in 2H22 to a net loosening by 4Q23. Moreover, this has been a broad-based improvement as the effect of past yield rises has faded, equity returns turned from a headwind to a tailwind and lending surveys have eased back significantly from their previous peaks. Based on quarter-to-date data for 2Q24 on 12-month changes to rates, spreads, returns as well as the 2Q24 lending surveys, this positive impulse from financial conditions appears to have continued.

Figure 2: Change in financial conditions in the US and Euro area

Positive (negative) numbers represent easing (tightening) in financial conditions.

Source: Bloomberg Finance L.P., J.P. Morgan.

Figure 3: US and Euro area financial conditions indicators

This table is based on IMF working paper 08/161 – “A US financial conditions index: putting credit where credit is due”, by Andrew Swiston. HY spreads are measured relative to the yield on HG debt. Bank lending standards only cover C&I lending. The level shows each financial variable as at 4Q22 and 2Q23. For yields the level is the 12-month change in basis points; for real equity returns and the real exchange rate the moves are 12-month % changes; for bank lending standards it is the %pt change in the % of banks tightening standards for C&I loans. The impact is the effect on the level of GDP of these moves in financial variables after one year.

US Euro area
4Q22 2Q24 4Q22 2Q24
Change Impact Change Impact Change Impact Change Impact
3m rate (bp) 456 -2.4 4 0.0 270 -1.4 21 -0.1
HG yield (bp) 267 -2.2 15 -0.1 303 -2.9 -25 0.2
HY spread (bp) 185 -0.5 -105 0.3 176 -0.5 -70 0.2
Real eq return (%) -23 -0.9 19 0.7 -24 -0.9 11 0.4
Real fx rate (%) 4.4 -0.3 1.4 -0.1 20.0 -1.3 3.1 -0.2
Loan officer survey 57.3 -2.1 -30.4 1.1 18.4 -0.7 -23.9 0.9
Total -8.4 1.9 -7.5 1.4

Source: Bloomberg Finance L.P., J.P. Morgan.

  • As we have noted previously, the methodology in the IMF paper estimated that the impact from a tightening in financial conditions on GDP typically takes between one and two years to be fully felt. While this suggests that the effect of previous tightening should be fading over time, and will increasingly be offset by the loosening that has taken place in 4Q23 and the first half of 2024. While in 2H23 central banks had pointed to tighter financial conditions substituting for further rate hikes, they appear to have largely de-prioritised financial conditions as they shifted to a tailwind. But this shift may have contributed to the positive inflation surprises since the turn of the year in the US. And to the extent they have, the catch-up in euro area financial conditions could mean that while the ECB is determined to start an easing cycle in June it could be challenged over further cuts in 2H24.
  • To look at the relationship between financial conditions and growth, Figure 4 shows the financial conditions indicator for the US along with y/y real GDP growth and Figure 5 shows the same for the Euro area. Looking at the relationship around the time of the financial crisis, the trough in the financial conditions index (i.e. peak tightening) preceded the trough in y/y real GDP growth by around 2 quarters, while in 2022 the financial conditions trough in 3Q22 was followed by a trough in y/y real GDP growth by one quarter. For the euro area, the 2008 trough in financial conditions occurred one quarter before the trough in real GDP growth, while the trough (peak tightening) in end-2011 preceded a trough in real GDP growth by more than a year. In the current conjuncture, the trough in financial conditions in 4Q22 was followed by a trough in real GDP growth after four quarters.

Figure 4: Financial conditions index and y/y real GDP growth for the US

Source: Bloomberg Finance L.P., J.P Morgan.

Figure 5: Financial conditions index and y/y real GDP growth for the Euro area

Source: Bloomberg Finance L.P., J.P Morgan.

  • What about the quantity side? To look at how credit creation has evolved, we turn first to bank lending activity. Figure 6 shows outstanding loans and leases on bank balance sheets from the Fed’s H.8 release, and suggests that, after pausing for around a quarter in the aftermath of the SVB crisis, loan growth resumed from mid-July, paused again around year end before picking up from the first week of January. Since then, loan growth has averaged an annualized pace of around $460bn. As we have argued previously, this growth is at least in part due to the liquidity offset from the declining use of the Fed’s ON RRP facility that more than offset the rebuild of the TGA and the balance sheet contraction largely due to QT and helped avert a more protracted contraction in bank liquidity that would have weighed on lending growth. However, with much of the ON RRP facility having been unwound, loan growth at the YTD annualized pace is likely required just to offset the effect of ongoing QT. Indeed, in the euro area where QT and maturing TLTRO’s have seen a contraction in reserves in the absence of an offset, loan growth been largely flat since November 2022 ( Figure 7). The level of outstanding loans in the euro area remains below its November 2022 level, though data for the first three months of the year suggests some signs of recovery with annualized loan growth of close to €135bn.

Figure 6: US commercial banks’ loans and leases


Source: Federal Reserve, J.P Morgan.

Figure 7: Euro area bank lending to non-banks excluding general government


Source: ECB, J.P. Morgan.

  • Another source of credit creation is through net issuance of debt securities. Figure 8 shows the monthly net issuance of US HG bonds for 2024 to-date, as well as for 2023 and the average for the previous five years. The significant strength of net issuance in January and February saw 1Q24 net issuance reach around $310bn, the second strongest quarter since 2000 after 2Q20, though there appears to have been some front-loading of issuance as the pattern for the first four months is surprisingly similar to 2023 with a drop-off in the pace in March and April. Similarly, net issuance in Euro HG bonds has been similarly strong at around €109bn YTD, compared to 2023 issuance of €128bn (European Credit Weekly, May 3rd), suggesting that while loan growth has remained muted credit growth via capital market issuance has been strong.

Figure 8: Monthly net issuance of US HG bonds


Source: Dealogic, J.P. Morgan.

  • In all, the above suggests the financial conditions impulse remains positive, posing some upside risks for growth and inflation.

The PBoC has been more contrarian than other central banks in terms of gold purchases

  • This week’s release on China’s FX reserves revealed further slowing in gold purchases by the PBoC in April. Figure 9 shows that April saw the lowest monthly gold purchases since the PBoC started buying gold in November 2022. April reflects the second month in row the PBoC slowed its gold purchases considerably, perhaps in response to rising gold prices, thus pointing to contrarian behavior.

Figure 9: Monthly gold purchases by the PBoC


Source: Bloomberg Finance L.P., J.P. Morgan.

  • In fact, by looking at quarterly flows in Figure 10, it looks like the PBoC has been more contrarian than other central banks in terms of gold purchases. While the PBoC slowed its gold purchases considerably in Q1, other central banks stepped up. And further back, looking at the correlation between quarterly gold purchases and quarterly gold price changes since Q4 2022, this correlation stood at -42% for China vs -34% for other central banks ex China.

Figure 10: Quarterly gold purchases by the PBoC vs other central banks


Source: World Gold Council, Bloomberg Finance L.P., J.P. Morgan.

  • The high overall gold purchases by central banks in Q1 have once again perturbed the historical sensitivity of gold prices to real bond yields. This is shown by the abnormally high residuals in Figure 11. These residuals are based on a linear regression of quarterly changes in the XAUEUR price to quarterly changes in the 10y real UST yield. We use the gold price in euro terms (i.e. XAUEUR) rather than dollar terms to adjust for changes in the price of dollar. As with other commodities, dollar is the settlement currency for gold and thus the gold price tends to be inversely related to dollar changes. One can see that the quarterly gold price change had been a lot higher in Q1 2024 (by around €200) than what the rise in the 10y real UST yield would typically imply. The typical sensitivity in the regression of Figure 11 is that each 100bp rise in the 10y real UST yield results to €209 decline in the price of gold and vice versa.

Figure 11: Residual from regressing quarterly changes of the XAUEUR price to quarterly changes in the 10y real UST yield

In euros.

Source: Bloomberg Finance L.P., J.P. Morgan.

  • There is little doubt that the pace of central bank purchases is key to gauging the future trajectory for gold prices. Indeed, the importance of central bank gold purchases has risen since the pandemic as shown by the correlation table of Figure 12. While before the pandemic gold ETF flows was the demand component exhibiting the highest correlation with gold prices, and thus the most important flow to watch, after the pandemic it has been central bank flows showing the highest correlation with gold.

Figure 12: Correlation between changes in (adjusted) gold prices with changes in gold demand

Correlation between changes in gold prices adjusted for dollar and real yield changes (i.e. the residuals of the regression in Figure 3) to quarterly changes of various demand components.

Correlation with regression residuals Pre-pandemic Post-pandemic
Jewellery fabrication -0.24 -0.29
Technology 0.04 -0.29
Total bar and coin -0.07 -0.13
ETFs & similar products 0.37 -0.01
Central banks & other inst. -0.35 0.46
OTC and other 0.04 -0.14

Source: World Gold Council, J.P. Morgan.

  • The fading of gold ETFs as an important demand indicator likely reflects a structural shift by private investors such as individuals and family offices away from physical gold ETFs to bars and coins. Privacy and tangibility have become a more important consideration for private investors since the pandemic and physical gold ETFs have a disadvantage in this respect relative to holding bars and coins. ETF transactions are recorded and their holdings are registered, thus lacking privacy and anonymity. And in a hypothetical catastrophic scenario for which investors are trying to hedge by buying gold, holding a paper certificate of gold ownership via an ETF, subjected to counterparty risk, looks less attractive and less safe than tangible gold stored privately. Indeed, at the same time as selling gold ETFs, private investors and individuals have been buying bars and coins in a rather strong and steady manner since the pandemic. And at $250bn cumulatively since Q3 2020 these bar and coin purchases have more than outweighed gold ETF sales (-$45bn) and have even outpaced the $175bn of gold purchases by central banks over the same period as shown in Figure 13.

Figure 13: Cumulative gold flows by private investors and central banks

In $bn.

Source: World Gold Council, Bloomberg Finance L.P., J.P. Morgan.

  • With demand for bars and coins by both private investors and by central banks remaining on an uptrend as implied by Figure 13, it is likely that gold price changes would continue to outpace those implied by real bond yields/dollar changes (i.e. the residuals in Figure 11 would be positive most of the time) .
  • For additional JPM research on gold see recent reports from our colleague Greg Shearer from our Commodities Research team.

SEC’ Wells notice to Robinhood should not pose an obstacle to an eventual spot ethereum ETF approval

  • The recent Wells notice by the SEC to retail trading platform Robinhood for unregistered security offerings, took markets by surprise. This is because Robinhood is more of a traditional trading platform with a smaller crypto trading share and a rather conservative approach towards listing and delisting of crypto tokens on its platform. Robinhood doesn’t offer staking products in order to be more compliant with the regulator. And Robinhood was prompt enough to delist three major crypto tokens (Cardano, Polygon , Solana) that were alleged to be securities by the SEC in its lawsuit against crypto exchanges such as Coinbase and Binance last year. 
  • However, Robinhood still offers trading on another 13 crypto tokens outside bitcoin and ethereum, and the SEC appears to consider all crypto tokens outside bitcoin and ethereum as securities. This perhaps is how the Wells notice against Robinhood should be seen, as a continued attempt by the SEC to reinforce its position that all crypto tokens outside bitcoin and ethereum should be classified as securities. In our mind, via continued notices and lawsuits against crypto exchanges including those with smaller crypto business such as Robinhood, it appears that the SEC aims at influencing US policy makers and legislators, who at some point would need to pass legislation on how the crypto industry should be regulated in the US. And the Wells notice against Uniswap and Metamask (behind which is Consensys) makes it clear that decentralized platforms are not exempted from the SEC’s objective to eventually supervise most of the crypto industry. 
  • In our opinion, it does not look like the Wells notice should pose an obstacle to an eventual approval by the SEC of spot ethereum ETFs, although perhaps not as soon as this month . The template is likely to be similar to bitcoin: with futures based ethereum ETFs already approved, the SEC ( if it denies the approval of spot ethereum ETFs) is likely to face a legal challenge and eventually lose. 
  • The lack of approval of spot ethereum ETFs this month is unlikely to be a huge disappointment by markets. In general, markets do not expect an approval by this month as implied by the significant discount to NAV of the Grayscale Ethereum Trust ETHE in Figure 14

Figure 14: Premium/Discount to NAV for the Grayscale ethereum trust ETHE

Source: Bloomberg Finance L.P., J.P. Morgan.


ETF Flow Monitor (as of 8th May)

Short Interest Monitor

Chart A11a: Cross Asset Volatility Monitor 3m ATM Implied Volatility (1y history) as of 7th May-2024

This table shows the richness/cheapness of current three-month implied volatility levels (red dot) against their one-year historical range (thin blue bar) and the ratio to current realised volatility. Assets with implied volatility outside their 25th/75th percentile range (thick blue bar) are highlighted. The implied-to-realised volatility ratio uses 3-month implied volatilities and 1-month (around 21 trading days) realised volatilities for each asset.

Spec position monitor

Mutual fund and hedge fund betas

CTAs – Trend following investors’ momentum indicators

Corporate Activity

Pension fund and insurance company flows

Credit Creation

Bitcoin monitor

Japanese flows and positions

Commodity flows and positions

Corporate FX hedging proxies

Non-Bank investors’ implied allocations

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Completed 08 May 2024 08:57 PM BSTDisseminated 08 May 2024 08:57 PM BST