Central bank interventions have become one of the most significant forces shaping global asset prices. When central banks inject liquidity through asset purchases or foreign exchange operations without offsetting the increase in base money—what economists call unsterilized interventions—they directly expand the monetary base. This expansion often influences asset prices across markets, especially when such policies persist over time.
Although markets typically respond to unexpected policy actions in real-time, longer-term trends in intervention liquidity offer valuable information. In currency areas where central banks provide more consistent liquidity support, equities and interest-rate sensitive assets have tended to perform better. Meanwhile, those same trends can put pressure on the local currency. These effects form the basis for using intervention liquidity as a signal in relative asset allocation.
Understanding Intervention Liquidity
Central banks conduct open market operations for various reasons—managing interest rates, stabilizing exchange rates, or supporting financial markets. When they buy securities or foreign exchange reserves without offsetting the transaction elsewhere in their balance sheet, they expand the monetary base. This increase in base money often translates into more credit, more leverage, and, ultimately, higher asset prices.
The past two decades have seen central banks around the world deploy these tools aggressively. Foreign exchange reserves alone have ballooned from under $1.5 trillion in the mid-1990s to nearly $13 trillion by the end of 2021. Add to that the trillions in securities acquired by central banks after the global financial crisis, and the role of liquidity in shaping market behavior becomes hard to ignore.
However, not all interventions are created equal. Some are sterilized, meaning they don’t expand the monetary base. This analysis focuses on unsterilized operations—those that simultaneously increase both assets and liabilities on a central bank’s balance sheet and thus have a more direct influence on liquidity in the financial system.
Tracking Liquidity in Practice
Daily estimates of intervention liquidity can be constructed using central bank balance sheet data. Though not as immediate as market announcements, this data provides a more comprehensive and consistent view of monetary intervention across countries. These liquidity estimates track changes in central bank assets—like FX reserves and special purchase accounts—against changes in the monetary base. If both rise together, it’s a sign of unsterilized intervention. If they move in opposite directions, the effect is considered neutral.
To normalize the impact across countries and over time, the liquidity trend is typically expressed as a percentage of nominal GDP and measured over multi-month windows. Trends over three to six months have proven particularly meaningful, with a high degree of correlation between past and future liquidity patterns.
Relative Value Applications in Global Markets
Rather than focusing on the absolute impact of intervention liquidity—which can be swamped by global macro forces—this approach looks at relative trends across countries. Comparing how much liquidity central banks are providing in one market versus others allows for more actionable cross-market positioning.
Equities
In theory, countries experiencing stronger liquidity injections should see equity markets outperform. Over the past two decades, relative six-month liquidity trends have indeed been positively correlated with subsequent relative returns in equity index futures across a set of 16 developed and emerging markets. Though the predictive accuracy hovers slightly above 50%, the strategy benefits from high trade frequency and low correlation with broad market benchmarks. A simple strategy based on these signals produced a Sharpe ratio of 0.3–0.4 over the period, even before transaction cost considerations.
Equity-Duration “Long-Long” Positions
Risk-parity strategies that allocate evenly between equities and fixed income also respond to liquidity dynamics. In these trades, liquidity expansion boosts both components: equities benefit from the supportive environment, and fixed income gains from potential yield compression. The relationship between relative liquidity trends and performance of these balanced portfolios has been strong and persistent, especially at quarterly frequencies. As with equities, the predictive power is modest per trade but statistically significant and consistent over time.
Currencies
The impact of liquidity is inverted in FX markets. A central bank pumping liquidity into its domestic economy may weaken the local currency relative to peers. This inverse relationship has shown up in forward FX returns, where countries with relatively high liquidity expansion tended to underperform. Although the signal is slightly weaker here—correlation coefficients are smaller, and prediction accuracy just above 50%—the large number of potential trades each year compensates. In fact, the relative FX strategy showed better average risk-adjusted returns than equity or long-long allocations, with Sharpe ratios reaching 0.4–0.5.
Conclusion: Liquidity as a Cross-Market Signal
Persistent central bank intervention liquidity trends offer a systematic way to identify relative value opportunities across equities, bonds, and currencies. These trends are not just a function of monetary policy announcements but reflect underlying macroeconomic pressures and central bank intent.
While the signal doesn’t deliver explosive returns on its own, it offers steady value and low correlation to traditional benchmarks. As part of a diversified macro strategy, intervention liquidity can play a critical role in improving risk-adjusted returns and navigating global asset allocation. In a world where policy remains a key market driver, tracking the flow of liquidity across borders may be one of the most practical edges an investor can have.
