With excess liquidity declining, the fate of European stocks is now in the hands of the Federal Reserve?

With the decline of global excess liquidity, European stock markets are facing greater downside risks. Analysts believe that the fate of European stocks is in the hands of the Federal Reserve; unless the Fed shifts to a more accommodative policy stance, European stock markets will be impacted by declines.

The latest data shows that the "excess liquidity," measured by the difference between the actual money growth and economic growth of G10 countries, has experienced its first decline in nearly two years.

Previously, global stock markets rebounded from the 2022 lows supported by excess liquidity, which exceeded the needs of the real economy and was thus available to support risk assets. However, now, Trump's economic policies are squeezing liquidity from multiple angles. Analysts point out:

"Trump's policies have boosted market expectations for U.S. economic growth and inflation, tightening excess liquidity in the U.S. while also leading to a rapid rise in the dollar."

Since excess liquidity is denominated in dollars, a stronger dollar means that non-dollar currencies are under pressure, further reducing excess liquidity in most European countries.

For the European and UK stock markets, which have recently reached or are close to new highs, this will become a resistance. Although the European Central Bank and the Bank of England can adopt a more accommodative stance to offset the decline in liquidity, the persistent inflation risk remains an obstacle, and they are also unlikely to openly support the stock market as the U.S. did in the past.

The Federal Reserve can exert the greatest influence. Analysts believe that although the upward momentum of U.S. currency has paused, if the Fed shifts back to a more accommodative policy, it will reignite monetary growth, helping to offset the suppressive effects of better economic growth expectations and the dollar's surge on liquidity.

However, on the other hand, the decline in excess liquidity indicates that U.S. stocks are about to experience instability. Analysts point out that once U.S. stocks begin to wobble, the Fed will face increasing pressure, as a president who openly supports the stock market may force it to shift to a more accommodative policy:

"Therefore, we should not lose confidence in the European stock market just yet."