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. Last Updated: 07/27/2016

Liquidity Squeezed as Tax Payments Surge

Liquidity flows will tighten this week alongside a surge in tax payments, expected to peak Tuesday and Wednesday, meaning that a lot of the cash that would usually be flowing through the markets will instead be set aside.

The flow of capital has already been strained for the past few weeks by investors paying for their bids on Sberbank shares emitted last month. The same kind of pressure is expected from the auctioning off of at least $24 billion in Yukos assets over the next two weeks.

Taken together, these factors are likely to result in surging rates on the money market, where short-term loans for investments are made. In a report last Tuesday, Renaissance Capital predicted that, at the height of next week's tax payments, money market rates will climb to as much as 10 percent, nearly twice the levels seen last week. Getting a loan for an investment will therefore get much riskier.

"Current borrowing costs may be low on a historic level, but they are too much for many borrowers to meet," said James Beadle, portfolio manager at Pilgrim Asset Management.

All of this comes at a time when fund managers are already quite wary of risk. Despite the fact that the RTS has recovered almost 70 percent of the value lost during the recent global correction, risk appetite dropped by about 12 percent this month, according to a Merrill Lynch survey of 119 global money managers. "This was one of the lowest readings seen in the last five years," said the report, which was released Wednesday.

Merrill Lynch also found that investors were cutting back their exposure to volatile sectors such as oil and gas, favoring the much safer consumer goods markets, or turning their investments to cash. This month, the cash balance of an average portfolio went from 3.8 percent to 4.4 percent, the report said.

"During the correction we clearly saw a drop in risk tolerance, as a lot of things were sold off. Now a lot of things are rallying again. But at some point we could see a much larger correction, especially in the fixed income market," said Rory MacFarquhar, an economist at Goldman Sachs.

MacFarquhar said renewed confidence in the U.S. economy would be the best cure for the liquidity crisis and for investors' aversion to risk. According to figures released Tuesday by the U.S. Commerce Department, construction started on 1.53 million new U.S. housing units in February, up 9 percent for the month after a 14.3 percent drop in January. These figures, combined with the decision Wednesday not to raise key interest rates in the United States, helped dispel fears of a recession in the world's biggest economy.

"Once this risk aversion passes, people will sit down and take stock of fundamentals. And the Russia story is hard to ignore if that's what you're looking at," MacFarquhar said.

But the runaway growth seen throughout this decade is almost surely a thing of the past. In the Merrill Lynch survey, only 11 percent of respondents still believe emerging market stocks are undervalued, down from 40 percent in January. Seventy-eight percent of respondents believe the values are now fair, leaving little room for upside.

"The risk is still very much on the downside over the next few months and the best-case scenario is for global emerging markets and Russia to move sideways within a tight range," said Chris Weafer, chief strategist at Alfa Bank.