Market strategists are warning of a potential pullback in the S&P 500 this June, driven by a temporary liquidity drain.
Broker-dealer Strategas Research said in a Wednesday report it expects a $130 billion liquidity drag beginning in late May and lasting through June, which could contribute to stricter financial conditions. The drain, according to the firm, is anticipated due to a mix of factors, including changes in the Federal Reserve's balance sheet and increased T-bill issuance.
One of the key drivers of this potential pullback is the Federal Reserve's actions. The Fed is expected to slow the pace of its balance sheet contraction starting in June, a move that is likely to put upward pressure on the dollar and bond yields, which historically led to a temporary dip in equity markets.
Moreover, Strategas pointed out the potential impact of upcoming Treasury actions. Starting in July, there will be a large increase in T-bill issuance, funded through money market funds parked in Reverse Repos.
While the shift in liquidity is expected to ease conditions after June, the near-term impact could be negative for stocks, the firm said.
“Liquidity through the Treasury General Account and Reverse Repos is highly correlated to the US dollar, United States 10-Year yields, and corporate bonds,” Strategas wrote.
Historical trends also support the likelihood of a pullback, with the S&P 500 witnessing similar patterns in past election years. Still, strategists remain optimistic about the overall market trajectory for 2024, driven by anticipated economic stimulus and infrastructure spending.
"June is a smaller hiccup compared to April, and once June clears out, we expect liquidity to flow through the election starting in July," they explain.
“We see more risk in 2025 than 2024 as the hangover from this easing, the stickiness of inflation, and the fiscal cliffs comes to fruition.”