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Tariff-induced inflation has the potential to prolong a market correction, depending on the scale of the tariffs, how central banks respond, and broader economic conditions.

If we looked at how $S&P 500(.SPX)$ have reclaimed the 200-day moving average, but there is a risk for S&P 500 dropping with the latest tariff announcement on the auto industry before the 02 April liberation day.

So if we were to monitor how things are developing, we could be seeing S&P 500 slipping back into correction if 02 April gave larger scale of the existing tariffs.

Fear and Greed Index At 29 Could See Panic Selling Coming

A Fear and Greed Index reading of 29 signals that markets are dominated by extreme fear. This metric (often tracked by CNN, Bloomberg, or other financial platforms) aggregates indicators like volatility, market momentum, safe-haven demand, and investor surveys to gauge sentiment. At such a low level, markets are typically pricing in panic, pessimism, or systemic risks.

We are seeing market behavior at extreme fear level which is shown one week ago, investors dump risk assets (stocks, crypto, junk bonds) in favor of cash, Treasuries, or gold. Prices may overshoot to the downside, creating potential bargains for contrarian investors.

Retail investors and weak hands exit positions, sometimes marking a short-term market bottom.

VIX Increasing Reflect Uncertainty and Share Price Swings Incoming

The $Cboe Volatility Index(VIX)$ (fear gauge) often spikes, reflecting uncertainty and sharp price swings. Fear-Driven Mistakes: Investors may sell quality assets at lows, lock in losses, or abandon long-term strategies.

As of current, we are seeing VIX showing signs of moving up, we need to see if it spikes, then we might also see investors into cash hoarding which could lead to market liquidity drying as money market funds and cash reserves swell as investors wait for "all-clear" signals.

But there will be contrarian opportunities where institutional investors (hedge funds, value buyers) often start accumulating undervalued assets.

Sectors Performance Worrying As Defensive Sectors Not Outperform As Expected

As we normally would like to see Defensive Sectors: Utilities, consumer staples, and healthcare stocks often outperform as investors seek stability. Cyclicals/Tech: Growth stocks (e.g., tech) and economically sensitive sectors (e.g., industrials, energy) may underperform.

Small-Caps: High-beta, speculative assets (small-cap stocks, meme stocks) often crash hardest. So far, we are seeing consumer cyclical and communication services coming back, but for one month period performance, that might not be enough.

So we might want to continue to look at 1 month performance, we can see that ten out of eleven sectors are not performing.

So as investors we might want to seek out safe haven like Gold $SPDR Gold Shares(GLD)$

Tariffs → Inflation → Market Pressures

• Higher Consumer Prices: Tariffs raise the cost of imported goods (e.g., electronics, vehicles, raw materials). Companies often pass these costs to consumers, driving inflation.

• Supply Chain Disruptions: Tariffs can fragment global supply chains, creating bottlenecks that further push up prices (e.g., auto parts shortages during the U.S.-China trade war).

• Wage-Price Spiral: If inflation becomes entrenched, workers demand higher wages, leading to a feedback loop that keeps inflation elevated.

Impact on Markets: Persistent inflation pressures central banks (like the Fed) to raise interest rates aggressively, which weighs on corporate earnings, equity valuations (via higher discount rates), and consumer spending. This could deepen or prolong a market correction, especially in rate-sensitive sectors (tech, real estate).

Prolonging a Correction: Key Mechanisms

• Reduced Corporate Margins: Companies facing higher input costs (due to tariffs) may see earnings shrink, leading to downward revisions in stock prices.

• Tighter Monetary Policy: If inflation remains stubborn, central banks may keep rates "higher for longer," stifling growth and extending market declines.

• Investor Sentiment: Uncertainty about trade policy and inflation can drive risk aversion, reducing liquidity and amplifying volatility.

• Sector-Specific Pain: Tariffs disproportionately harm industries reliant on imports (e.g., retailers, automakers), dragging down broader indices.

Historical Precedent: 2018–2019 U.S.-China Trade War

• Inflationary Impact: The U.S. tariffs on $360B of Chinese goods raised prices for consumers by ~1% (Fed study), but inflation remained muted due to offsetting factors (strong dollar, delayed pass-through).

• Market Reaction: S&P 500 fell ~6% in Q4 2018 as trade tensions spiked, but markets rebounded in 2019 when the Fed cut rates to counter slowing growth.

• Key Lesson: Central banks may prioritize growth over inflation if tariffs threaten economic activity, shortening the correction.

When Tariffs Worsen a Correction

• Stagflation Risk: If tariffs combine with slowing growth (e.g., recession), central banks face a lose-lose choice: fight inflation (crushing markets) or cut rates (letting inflation run). This uncertainty prolongs market stress.

• Retaliatory Tariffs: Trading partners (e.g., EU, China) may retaliate, hurting U.S. exporters (e.g., agriculture, tech) and amplifying global demand weakness.

• Liquidity Crunch: Tariff-driven inflation could coincide with tighter financial conditions (e.g., bond sell-offs), straining leveraged firms and markets.

Mitigating Factors

• Fed Flexibility: If inflation is driven only by tariffs (not broad demand), the Fed might tolerate it temporarily, avoiding over-tightening.

• Supply Chain Adjustments: Companies may re-route production to tariff-free countries, easing cost pressures over time (e.g., "reshoring" to Mexico/Vietnam).

• Political Resolution: A trade deal (e.g., tariff rollbacks) could quickly reverse inflation fears, sparking a market rebound.

When market liquidity dries up, it means buyers and sellers struggle to execute trades without significantly impacting asset prices. This creates a cascade of risks across financial markets, economies, and investor behavior. Here’s what typically happens:

Immediate Effects of Drying Liquidity

1. Widening Bid-Ask Spreads: The gap between what buyers are willing to pay (bid) and sellers are asking (ask) grows, making transactions costlier and slower.

2. Price Volatility Spikes: Thin trading volumes amplify price swings. Even small trades can cause sharp moves, eroding confidence (e.g., "flash crashes").

3. Asset Fire Sales: Investors or institutions needing cash may sell assets at steep discounts, further depressing prices and triggering margin calls.

4. Reduced Market Depth: Fewer participants are willing to take the other side of trades, especially for less liquid assets (e.g., corporate bonds, small-cap stocks).

Causes of Liquidity Crunches

• Central Bank Tightening: Rising interest rates (e.g., Fed hikes) reduce cheap money, shrinking liquidity.

• Risk Aversion: Panic during crises (e.g., 2008, COVID-19) leads investors to hoard cash or safe havens (e.g., U.S. Treasuries).

• Regulatory Constraints: Post-2008 rules (e.g., Basel III) limit banks’ ability to act as market-makers.

• Algorithmic Trading: High-frequency traders (HFTs) and ETFs may withdraw liquidity during stress, exacerbating dislocations.

Broader Economic and Financial Impacts

1. Credit Freezes: Banks and lenders tighten credit, hurting businesses and consumers. Example: 2008, when interbank lending froze.

2. Corporate Distress: Companies struggle to refinance debt or raise capital, increasing defaults (e.g., junk bond sell-offs in 2020).

3. Contagion: Illiquidity in one market (e.g., mortgage-backed securities in 2008) spills into others, creating systemic risk.

4. Central Bank Intervention: Authorities may step in as "lender of last resort" (e.g., Fed’s quantitative easing, repo market injections in 2019).

Historical Examples

1. 2008 Global Financial Crisis: Liquidity vanished in mortgage-backed securities, leading to bank collapses (Lehman Brothers) and a global recession.

2. COVID-19 Crash (March 2020): Panic selling drained liquidity from Treasuries and equities, forcing the Fed to inject $2.3 trillion into markets.

3. 2019 Repo Market Crisis: Overnight lending rates spiked due to a sudden liquidity shortage, requiring Fed intervention.

4. 2022 UK Gilts Crisis: A liquidity crunch in UK government bonds forced the Bank of England to buy bonds to stabilize pension funds.

How Investors and Institutions Respond

• Flight to Safety: Investors rush into cash, gold, or government bonds.

• Liquidity Hoarding: Banks and funds hold more cash, worsening the crunch.

• Firefighting Tools:

  Circuit breakers (halt trading during extreme volatility).

  Central bank liquidity facilities (e.g., discount window, swap lines).

  Government bailouts (controversial but sometimes necessary).

Long-Term Consequences

• Economic Slowdown: Reduced investment and consumer spending.

• Erosion of Trust: Investors may avoid illiquid markets for years.

• Regulatory Reforms: Tighter rules (e.g., stress tests, liquidity coverage ratios) to prevent future crises.

Summary

As we monitor how things have developed, from S&P 500 went into correction then came out for a small short rally, but all these does not seem to be enough, and we are now seeing investors and market very concerned of more tariff impact, this could lead to market liquidity drying up if we continue to see selloff.

Liquidity drying up is a self-reinforcing cycle: fear reduces trading, which fuels more fear. While central banks can provide short-term fixes (e.g., QE), structural issues (leverage, derivatives, globalization) make markets vulnerable to recurring liquidity shocks. Investors should diversify, avoid over-leverage, and monitor liquidity conditions in stressed markets.

Appreciate if you could share your thoughts in the comment section whether you think market liquidity drying up could have the bull market out of sight for a longer period.

@TigerStars @Daily_Discussion @Tiger_Earnings @TigerWire appreciate if you could feature this article so that fellow tiger would benefit from my investing and trading thoughts.

Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.