Where does the market’s “water” come from, and where does it flow?

If there’s one common force that moves both equities and crypto, it’s liquidity. Liquidity is the amount of money in the system and how quickly it circulates. As the tide rises and lifts most boats, abundant liquidity tends to put a tailwind behind risk assets, while when the tide goes out, even good boats can run aground. This post lays out the core gauges of global liquidity in plain terms, how changes transmit into equities and crypto, what history shows, and three scenarios heading into 2025.

Core gauges for reading global liquidity

Combined balance sheets of the G5 central banks (G5 CB Balance Sheets)

The sum of the assets held by the Fed, ECB, BoJ, PBoC, and BoE is the “main stream” of global liquidity. When quantitative easing (QE) expands those assets, it injects base liquidity into the system; quantitative tightening (QT) withdraws it. The direction (year-over-year, YoY) and the slope (speed of change) matter.

Why it matters: Expansions and contractions of major central bank balance sheets directly set the supply of reserve currencies (USD/EUR/JPY, etc.), shaping risk appetite across both equities and crypto.

Global M2

This aggregates broad money (M2) across major economies—cash, deposits, and other liquid balances. When M2 growth decelerates, the “speed of water” slows; when it reaccelerates, the “ripples” build.

Why it matters: It’s a foundational gauge of the money pool backing the real economy and finance, and it tends to correlate with asset prices with a lead of a few quarters.

US net liquidity (Net Liquidity: Fed BS − TGA − RRP)
  • Fed BS: The Federal Reserve’s assets (primarily Treasuries and MBS)
  • TGA: Treasury General Account—the government’s cash balance at the Fed
  • RRP: Reverse repo balance—a “parking lot” for cash Net liquidity = Fed assets − TGA − RRP; a simplified, high-frequency gauge of liquidity available to markets. Rising TGA or RRP effectively “pulls” cash out of circulation.

Why it matters: It moves month-to-month and correlates strongly with short-term swings in risk assets. Crypto, in particular, tends to react sensitively to this gauge.

Dollar Index (DXY) and real yields (US 10Y TIPS real yield)

A strong USD (high DXY) and higher real yields both tighten global dollar liquidity. When they rise together, risk assets typically face pressure.

Why it matters: Funding conditions tighten for USD-indebted companies and countries, making deleveraging more likely. Crypto often sees outsized volatility in such periods.

Global Financial Conditions Index (FCI)

There are versions from Goldman Sachs (GS Global FCI), Bloomberg, BIS, and others. They combine rates, spreads, equities, and FX to score how easy or tight financing conditions are. Higher readings (tightening) are headwinds; lower (easing) are tailwinds for risk assets.

Why it matters: It’s an intuitive, holistic view of how policy shifts propagate across markets.

China’s credit impulse and Total Social Financing (TSF)

Changes in China’s credit impulse—i.e., the pace of incremental credit creation—are often used as a 6–9 month leading indicator for global manufacturing, commodities, and EM liquidity.

Why it matters: It shows when money is being pushed to the “demand side” of the global economy, with spillovers into commodities, semis, EM equities, and even Bitcoin’s directionality.

Dollar funding stress
  • Cross-currency basis
  • OIS–Treasury spreads (e.g., SOFR–OIS)
  • TED spread (historical convention) When these spreads spike, short-term dollar funding can seize up, rapidly shrinking liquidity.

Why it matters: It’s an environment ripe for a volatility spike (VIX surges) and correlated drawdowns in risk assets.

Crypto-native liquidity
  • Stablecoin market cap (USDT, USDC, etc.)
  • Derivatives funding rate; spot–futures basis
  • Spot ETF net inflows Why it matters: These measure the “water level” within the crypto ecosystem, helping disentangle idiosyncratic inflows/outflows from broader macro liquidity.

Liquidity and the correlation between equities and crypto

Common ground: Liquidity moves multiples and spreads
  • Equities: Easier liquidity compresses discount rates and risk premia, pushing valuation multiples (e.g., P/E) higher. Indexes can rise even on mediocre earnings.
  • Crypto: With no cash flows, crypto’s “beta to liquidity” is very high. Weaker USD and lower real yields tend to strengthen rallies in Bitcoin and altcoins.
Differences: Sensitivity and speed of response
  • Crypto trades 24/7, uses leverage readily, and has a smaller market cap relative to marginal inflows—hence far greater volatility than equities.
  • Equities have buffers—EPS, dividends, and buybacks—that can dampen pure liquidity effects.
Lead–lag
  • Global M2 and G5 balance sheets vs. equities: Often lead by 3–6 months.
  • China credit impulse: Leads global manufacturing/commodities by 6–9 months; EM and Bitcoin often move in sympathy.
  • US net liquidity: Sensitive for short-term direction in both equities and crypto, with faster transmission to crypto.

Key point: Correlations are regime-dependent and can temporarily break on policy, regulation, or one-offs (e.g., BTC spot ETF approval).

How liquidity ties to prices: case studies

  • 2008–2009 post-crisis: Massive Fed QE drives a surge in G5 balance sheets; S&P 500 and EM equities rebound. Bitcoin was nascent, but subsequent cycles showed its strong liquidity sensitivity.
  • 2013 taper tantrum: Even hinting at QE taper triggered a sharp tightening in financial conditions; EM and risk assets corrected.
  • 2018 QT ramps up: Balance sheet runoff plus USD strength widened volatility in risk assets.
  • 2020 pandemic: Unprecedented QE and fiscal support spiked M2; both equities and crypto rallied strongly.
  • 2022 tightening cycle: Aggressive hikes and QT, with real yields jumping and USD strengthening—equities fell; crypto dropped even more.
  • 2024 crypto ETFs: Structural on-ramps for capital into crypto enabled selective strength even without fully supportive macro liquidity. Still, strong USD/rising real yields saw volatility rise.

The track record points to one pattern: “When liquidity tailwinds blow, both rise. When headwinds hit, crypto shakes harder.”

Three scenarios for 2025

1) Gradual easing (base case)
  • Setup: Inflation cools gradually; major central banks deliver measured cuts and moderate QT. US Treasury tilts issuance toward bills, managing TGA/RRP to keep net liquidity neutral to supportive.
  • Implications: DXY soft/sideways, real yields drift lower. Global FCI eases. Equity multiples hold up; in crypto, stablecoin market cap growth plus ETF inflows could drive high-beta upside.
2) Sticky inflation (risk case)
  • Setup: Services inflation and wages stay elevated; rate cuts are delayed; long-end and real yields rise; strong USD returns.
  • Implications: FCI re-tightens; valuation pressure. Equities see narrow leadership in sectors with strong earnings momentum; crypto volatility rises and smaller-cap alts lag. Flows may concentrate in ETFs, but broad-based strength is capped.
3) Liquidity shock (tail risk)
  • Setup: Geopolitical shock, a credit event, USD funding stress (cross-currency basis blowout), or BoJ normalization triggering a yen-carry unwind.
  • Implications: “Cash is king.” Deleveraging can cause a correlated selloff in risk assets. Once policy response (QE restart, expanded swap lines, etc.) is confirmed, rebounds follow.

Reality will be a mix. Early 2025’s tilt should be clearer by watching the co-movement of DXY, real yields, net liquidity, and FCI.

A simple dashboard for individual investors

Check weekly (quick)

  • DXY: Up (↑) warrants caution; down (↓) can be a tailwind
  • US 10Y TIPS real yield: Down (↓) is supportive for risk assets
  • VIX: Spikes flag liquidity strains
  • Total stablecoin market cap: An uptrend signals improving crypto-native liquidity

Check monthly (deep dive)

  • G5 central banks’ total assets YoY: Watch for a turn positive
  • US net liquidity: Trend and inflection points
  • GS Global FCI (or similar): Direction of easing/tightening
  • China credit impulse/TSF: Rebounds imply risk appetite may recover 6–9 months later
  • US Treasury issuance mix: A higher bill share is neutral to supportive for near-term liquidity

Positioning/risk management tips

  • Consider adjusting exposure when three or more signals point the same way
  • Crypto’s volatility is high; predefine cash/stablecoin buffers and leverage limits quantitatively
  • Use rules-based beta adjustments around event risk (central bank meetings, CPI, jobs reports, regulatory announcements)

Keep it balanced: the pitfalls and exceptions of correlation

  • Correlation isn’t permanent: ETF approvals, major tech shifts (AI demand boom), buyback waves, and regulatory changes can temporarily override the liquidity cycle.
  • Earnings and productivity: Over the long run, earnings drive equities. Liquidity moves multiples, but when the cycle turns, assets without earnings support correct first.
  • The “quality” of liquidity: The impact differs depending on where liquidity goes (households vs. corporates vs. government; onshore vs. offshore), even for the same headline size.
  • Regional/currency divergence: In strong-USD regimes, pockets of local liquidity (e.g., Japan, Middle East capital flows) can still support specific sectors/themes.

Key takeaways

  • The pillars of global liquidity are G5 central bank balance sheets, Global M2, US net liquidity, DXY/real yields, and FCI.
  • Liquidity easing tends to lift equity multiples and crypto together; tightening does the opposite. Crypto is more sensitive.
  • Past cycles tell the same story. The direction in 2025 also starts with these gauges flashing in unison.
  • Track a simple dashboard to gauge the “water level,” and manage exposure and volatility when signals align.

Glossary

  • Liquidity: The abundance of capital and ease of trading in markets
  • QE/QT (Quantitative Easing/Tightening): Liquidity provision/withdrawal via central bank asset purchases/runoff
  • G5 CB Balance Sheets: Combined assets of the Fed, ECB, BoJ, PBoC, and BoE
  • Global M2: Aggregate broad money across major economies
  • Net Liquidity: Fed assets − Treasury General Account (TGA) − Reverse Repo (RRP)
  • TGA (Treasury General Account): The US Treasury’s cash account at the Fed
  • RRP (Reverse Repo): A mechanism for the private sector to place short-term cash with the central bank
  • DXY (Dollar Index): A measure of the USD’s strength versus a basket of currencies
  • Real yield: Nominal yield − expected inflation (e.g., 10Y TIPS yield)
  • FCI (Financial Conditions Index): A composite of rates, spreads, FX, and equities tracking financing conditions
  • Credit impulse: The change in the pace of new credit creation
  • Cross-currency basis: A measure of funding distortions in FX swap markets
  • Stablecoin market cap: Total capitalization of USD-pegged coins
  • Funding rate: The periodic cost/credit in derivatives used to align futures with spot demand
  • Spot ETF net inflows: Net cash moving into spot exchange-traded funds

Track a handful of easy-to-read indicators consistently and the market’s “waterways” come into view. Once you see the direction, you can set the speed with position management.