Net Liquidity: A comprehensive look at a vital financial metric

The ongoing market instability has put a spotlight on monetary policies across the world. Investors and analysts have long warned about the shortsightedness of extreme quantitative easing during the COVID-19 pandemic, correctly predicting its negative effects on the market.

Since 2020, a considerable portion of the global market has been focused on central banks, as their actions and decisions seem to have been the biggest driver of market changes in the past three years. This was most obvious in the U.S., where the Federal Reserve has been directly responsible for volatility across crypto and the traditional financial market.

Investors and traders have been timing the market according to FOMC meetings anticipating interest rate rises and following the Fed’s balance sheet trends to determine the amount of liquidity in the market.

Graph showing the Federal Reserve’s balance sheet in millions of dollars from 2008 to 2023 (Source: Federal Reserve)

This approach has been relatively successful. Major market volatility correlated with brief drops in the Fed’s balance sheet. FOMC meetings were always followed by notable market movement, serving as a solid gauge for unpredictability.

However, this rather binary approach to market analysis has many shortfalls. Most notably, the financial market in the U.S. is too complex to be fully understood just through the Fed’s balance sheet and interest rates.

In this report, CryptoSlate dives deep into net liquidity, an overlooked metric representing the actual amount of money available in the economy, to determine its effects on the market.