Liquidity of US Market Approaching a turning point
Global risk asset preferences rose in February, with markets such as BTC $iShares Bitcoin Trust(IBIT)$ and $NASDAQ(.IXIC)$ continuing to rise, ignoring expected interest rate cuts and rising US treasury yields. The release of liquidity in the first quarter drove the performance of risk assets, with the approval of Bitcoin spot ETFs and the performance of US tech stocks exceeding expectations. These factors were all supported by the ample liquidity in the US financial market. $S&P 500(.SPX)$
However, financial liquidity may shrink in the second quarter, which could lead to a redistribution of funds between stocks and bonds. The impact of the US liquidity transition on risk assets is something investors need to pay attention to.
Overseas assets may be doubly impacted by the contraction of financial liquidity and the expected interest rate cuts in the second quarter of this year, making the situation more complex.
All in all, on the eve of the US financial liquidity turning point, we believe that overseas assets are more inclined towards bonds in the short term and stocks in the long term. Currently, US bonds are more attractive than US stocks.
The financial liquidity indicator reflects how much "money" is in the market. Its increase means more "money" in the market. But how funds are allocated depends on market risk preference. In the case of abundant funds, if the market risk preference rises, it will lead to more funds flowing to higher-risk assets, which is a common situation we have seen in the past few years.s
The recent expansion of financial liquidity has promoted global risk preference, mainly due to the large-scale release of reverse repos. Repo funds are the "deposits" in the Fed's account, serving as a buffer for US financial liquidity. The decrease in repo funds means that non-bank institutions withdraw funds from the Fed's account, "activating" the funds, leading to an increase in the scale of reserve funds, thereby expanding financial liquidity. However, if the liquidity index shrinks, it may bring stage pressure.
Considering the Treasury's debt issuance plan, the Fed’s table shrinking pace and the monetary policy path, we predict that the financial liquidity index may shrink in the second quarter. The Fed continues to shrink the table and stop using BTFP. This means that the liquidity index will fall.
At present, "buy bonds in the short term and hold stocks in the long term" is a suitable investment strategy. For US bonds, the decline in risk preferences, the reduction in bond issuance, and the expectation of interest rate cuts constitute favorable factors. However, for US stocks, the tightening of financial liquidity in the second quarter could bring about 8% retracement pressure, which may have a greater impact on NASDAQ.
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