What Is a Liquidity Driven Market?

Many professional or institutional investors dub this market one that is liquidity driven. So what does that mean and why should you care. In a prior post I mentioned the unprecedented amount of liquidity or money being pumped into the financial system by central banks. Thus, why some call current conditions liquidity drive vs fundamental drive. Essentially what it may mean is that the amount of liquidity provided by central banks is playing more of a role in determining prices vs actual fundamentals of the underlying assets. Many refer to this as asset price distortion and can be very dangerous if prices decouple significantly from their fundamentals. Why? Because once liquidity gets reduced prices can revert back to their fundamentals which may or may not have improved. Central Banks hope that the additional liquidity is used to create economic growth via banking system. But that may not be the case as there is evidence its being used as leverage to purchase financial assets vs for general business use. Thus, why we say one of the keys to successfully navigating markets may come determining what is driving prices and whether it can be sustained.

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