A flood of liquidity has breached the wall of worry, allowing markets worldwide to move up. One big source of global liquidity has been money flowing out of the ultra-safe haven of US money market funds.
The Bloomberg chart of US money market funds shows that assets in these funds increased from around $1.9 trillion (Rs84.6 trillion) in April 2004 to $2.5 trillion by April 2007, when the first rumblings of the what was then believed to be the subprime mortgage crisis were heard. Within a year, by July 2008, assets in these funds rose by another trillion dollars.
Then Lehman Brothers Holdings Inc. went bust in September 2008 and the panic that ensued led to a rush of money into safe havens. By January 2009, assets in US money market funds totalled $3.9 trillion.
Since March last year, however, investors have been withdrawing money from the money market funds and investing them in riskier assets. Assets in these funds have therefore shrunk from $3.9 trillion in March 2009 to $2.9 trillion by the end of March.
Indeed, the slope of the chart has steepened recently, an indication that fewer investors are satisfied with the low returns on these funds and are now looking for higher returns from taking on more risk. It’s no coincidence that the fall in US money market assets correlates nicely to the rise in global equities since March last year.
Currently, assets in US money market funds are back to levels last seen in November 2007. But with these funds paying a pittance, it’s probable that there’s still scope for money to continue to flow out of them.
Also, the rush of money into emerging markets has pushed up their currencies against the US dollar, adding to returns for dollar investors. For instance, MSCI India’s year-to-date returns, as on 5 April, have been a low 3.51% in rupees, but it’s as high as 8.39% in dollar terms. No wonder then that foreign investors seem keener on the Indian market than local institutions.
Interestingly, the dollar has been weakening against the rupee at the same time as it has been strengthening against the euro. For instance, returns from MSCI Europe index are 4.19% year-to-date in local currency terms, but they are minus 1.06% when computed in US dollars.
The liquidity that matters for the Indian market is not so much domestic liquidity as FII inflows. The big question is: Will tighter monetary policy in the US choke liquidity?
Developed economies are still fragile and their policymakers are likely to tread cautiously before rocking the boat. That should keep liquidity abundant.