With the Consumer Price Index (CPI) and Producer Price Index (PPI) exceeding expectations once again, and economic activity data appearing somewhat weak, investors are left pondering why equity markets continue to rally.
Despite what seems like an unfavorable combination, stocks have so far remained largely unfazed.
“It could be because the current data flow in fact maintains the 'not too hot, not too cold' status quo,” Barclays strategists said in response to these concerns.
“With the Fed so far endorsing current market pricing of three cuts starting in June, investors continue to see the glass half full on the soft landing narrative,” they noted.
Moreover, the significant cash poised for investment in risk assets, amounting to approximately $1.5 trillion recently directed into money market funds, fuels optimism.
However, if rising inflation leads the Federal Open Market Committee (FOMC) to adopt a more aggressive stance, altering expectations for rate cuts, it could challenge the ongoing equity market rally, cautioned the strategists.
Apart from potential adjustments to the future interest rate path, the tapering of Quantitative Tightening (QT) is another crucial element to monitor in the coming months. Concerns about reduced central bank liquidity, after years of rate increases and recent QT, have seemingly had little impact on the enduring bull equity market.
“Bullish price action in the likes of Tech, credit or cryptos suggests there is no shortage of liquidity, actually quite the opposite,” Barclays’s team wrote.
“Indeed, excess liquidity in the US banking sector has been very supportive, with RRP (Reverse Repurchase Agreement) draining at a faster pace and leading to a build up of banks reserves.”
As the RPP funds decrease, reserve expansion cannot continue indefinitely, though there are still a few months left. Investors are beginning to raise concerns that QT might eventually impact asset prices.
Recent Federal Reserve communications hint at a cautious approach to balance sheet reduction and a possible QT tapering after depleting the RRP.
“More clarity on this would be welcomed to reassure investors,” the team said.