Short-term exuberance alert

trailing 12m cb liquidity down, equities up
  • We have been arguing markets face greater risk of melt-up than melt-down
  • But the speed and extent to which many levels are deviating, not only from fundamentals but even from many technicals, is striking
  • Expect fund inflows to continue to swamp such concerns – but watch for any sign of faltering

The asymmetric Fed

cash assets at small and large us banks still far from 2019 lows
  • The significance of last week’s FOMC lies neither with the rate view, nor with the earlier, larger taper of QT – mildly bullish though both of these are.
  • It comes instead from the stark asymmetry of the response function which was described.
  • While the true test remains with the details of the liquidity outlook, in conjunction with the Treasury refunding this opens the door to a continued cross-asset rally through Q2.

Cliff notes on credit

ccc-b spread differential ratio to hy index spreads at record highs
  • Relative CCC cliff risk has risen to record highs
  • This partly reflects hidden idiosyncratic risks from low recoveries and abandoned covenants
  • But mostly it signifies the macro suppression of index spreads

When crowding stops, markets drop

fund flows vs cb liquidity
  • The $280bn weekly drop in Fed reserves is the largest since Apr22
  • Just as then, it coincides with a correction in markets
  • A drop in fund inflows seems likely to follow
  • But this still feels more like seasonal correction than decisive turn

Global QT: what central banks haven’t learned

fed reserves vs equities 6m chg
  • The latest central bank research on QT is careful, rigorous, and grounded in the literature
  • Unfortunately its main conclusion – that QE affects markets while QT doesn’t – is at odds with the lived experience of most market participants
  • There is a much simpler reason why QT has had so little apparent impact
  • Misunderstanding of this dynamic greatly contributes to the likelihood of future policy mistakes

Sticky supply, not dynamic demand

labour hoarding
  • After several months of liquidity tailwinds, risk asset pricing is starting to look excessive
  • Improving spending, orders and hiring are all positives
  • Despite this, earnings estimates are falling
  • Fundamentals are reflective more of sticky supply than of dynamic demand
  • Ongoing price pressures may well curtail central banks’ desire for dovishness
  • But excitement about higher r* remains overdone

Seasonal Satorical Verses (free)

AI-generated central bank christmas scene
  • Hark! The VC angels sing
  • God rest ye, merry crypto bros
  • While PMs watched tech stocks take flight
  • I’m dreaming of a tight market
  • To be sung, please, in a spirit of global harmony

The #1 rule about outlooks

fed reserves vs spx
  • The biggest surprise of 2023 was not the resilience of the US consumer
  • It was that central banks added nearly $1tn in liquidity, rather than removing $1tn as had been widely expected.
  • This swing alone is worth 20% on equities – almost exactly the YTD gain in the S&P.
  • We think 2024 will show central banks have overtightened rates whilst simultaneously overstimulating risk assets.
  • But we also fear their misunderstanding of the dynamics means they may yet do more of both.

Central bank liquidity update

6m central bank liquidity vs equities
  • Poor risk asset performance in Sep/Oct reduces gap to CB liquidity
  • Fed $300bn reserve increase over past eight weeks helps explain renewed rally in S&P
  • Conversely, despite talk of stimulus, China liquidity injections remain lacklustre
  • Liquidity outlook still driven by RRP – and is much less negative than might be expected
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