Banking group IIF sees liquidity peaking

The huge wave of liquidity unleashed by major central banks in the past four years to fight crises could be peaking, a top official of the IIF global banking group said Thursday. "The liquidity cycle is beginning to turn," said Hung Tran, first deputy managing director of the Institute of International Finance. Financial markets have benefited significantly from the flood of liquidity, which drove a lot of the investment activity as investors searched for yield amid a low interest-rate environment, Tran said. And liquidity remains plentiful and seems to be increasing all the time, he said, pointing to the Federal Reserve's expansion last month of a third round of quantitative easing, to a monthly $85 billion in bond purchases. "But the music has started to stop," Tran said at a news briefing at the Washington headquarters of the association, which represents more than 450 financial institutions worldwide. Tran highlighted that participants at the Federal Open Market Committee's December meeting were considering ending QE3 sooner than the end of this year, according to the minutes of the meeting. Outlining a scenario that could prompt the FOMC to pull the plug, Tran said the US economy would be doing "not super, but decent." The housing sector would be making a strong comeback, manufacturing exports would be doing well and state and local governments would be adding jobs this year, reversing layoffs that had acted as a drag on the recovery. In Europe, several banks have recovered, he noted, thanks to supportive actions from the European Central Bank. Under his European scenario, several banks will decide to repay their ECB loans ahead of the three-year deadline because "they may not need the money." They borrowed the money because of fears that they could lose access to markets due to a lack of enough liquidity, not because they needed it for lending, he explained. "In the investor community, you see the end of QE3 here, the repayment of ECB liquidity there, meaning the liquidity cycle is beginning to turn." "And since a lot of financial market buoyancy has been liquidity-driven... the correction can come because rates are very low," he said. "If you have a near-zero policy rate, it doesn't take much for the rate to increase -- not that the economy is growing gung-ho or anything, but just liquidity is perceived to be not coming the way it has."