Be cautious: Why is there pressure on the US stock market in the third quarter? Losing liquidity is the "catalyst"!
According to CICC's judgment, due to the probable weakening of US financial liquidity in the third quarter, the support for US stocks will be significantly weaker than in the second quarter. US stocks in the third quarter may be somewhere between the "strong" of the second quarter and the "weak" of last year. There may be some pressure in the fourth quarter before successfully stimulating expectations of easing, followed by a rebound.
Due to the probable weakening of US financial liquidity in the third quarter, the support for US stocks from this perspective will be significantly weaker than in the second quarter.
From the perspective of the US macro environment, the current assessment of the US is that the growth in the third quarter will slow down but not be very weak. It is a phase of weakening growth that cannot provide upward support for profits, but it is not so bad as to immediately generate expectations of interest rate cuts. Correspondingly, there will be volatility in US bond yields, and in fact, there will be a rapid decline in core inflation in the third quarter, which will serve as a "hedge".
In the fourth quarter, there will be a slight inflationary pressure and relatively greater growth pressure. At that time, it will be possible to push down US bond yields by inducing expectations of easing, in order to offset the tightening of financial liquidity.
US stocks in the third quarter may be somewhere between the "strength" of the second quarter and the "weakness" of last year. There may be some pressure in the stage before successfully inducing expectations of easing in the fourth quarter, followed by a rebound. As for the US dollar, the current oversold condition and the tightening of liquidity in the third quarter may still provide support for the US dollar. It is too early to judge the turning point of the trend.
Changes in US financial liquidity: Continued balance sheet reduction + Gradual expiration of loans borrowed by the Federal Reserve during the banking crisis + Suspension of debt issuance by the Treasury after reaching the debt ceiling
Compared to the baseline of a monthly reduction of $95 billion (Treasury bonds $60 billion + Mortgage-backed securities $35 billion), the expansion of the above-mentioned indicators of US financial liquidity in the second quarter was mainly due to:
The Federal Reserve provided a large amount of short-term loans such as BTFP to support the liquidity of problem banks (within two weeks after mid-March, the Federal Reserve's total loans increased by $39 billion, equivalent to 4% of total assets);
The debt ceiling constrained the issuance of debt by the Treasury.
Looking ahead to the third quarter, as the banking crisis gradually subsides, the demand for loans will decrease and gradually expire, and the debt ceiling will be resolved, both of the above-mentioned factors will reverse. In fact, since late June, the above-mentioned liquidity indicators have gradually started to decline, and by the end of June, the total assets of the Federal Reserve had returned to the level before SVB Financial.
- Short-term loans to hedge against the banking crisis: The sharp increase in the second quarter caused financial liquidity to temporarily rebound to pre-reduction levels, but it will gradually decrease as these loans expire. We expect that the increase in loans causing incremental liquidity will completely dissipate by the second quarter of next year.
- Debt issuance by the Treasury after reaching the debt ceiling and accumulation of own funds (TGA account)
Based on the above discussion, unless there is another banking crisis that requires the intervention of the Federal Reserve to provide liquidity, the continuation of balance sheet reduction, the expiration of loans, and the issuance of new government bonds will cause financial liquidity to reverse and decline.
According to CICC's calculations, the current reduction of $285 billion in the third quarter, $84 billion in loan maturities, $88 billion increase in the TGA, and the offsetting effect of the $305 billion decline in reverse repurchase agreements, will reduce our financial liquidity indicators from the current $5.62 trillion to $5.47 trillion. Back to the level at the end of last year.**
Market Impact: The liquidity support for the U.S. stock market in the third quarter was weaker than in the second quarter, but better than last year; the U.S. dollar may also find support, but it is still too early to determine the turning point.
From the perspective of the mid-term market trend, changes in financial liquidity have a good explanatory power for both the U.S. stock market and the U.S. dollar, especially when other factors such as fundamentals do not play a dominant role. Of course, when the fundamentals are very strong, the pressure from liquidity contraction can be hedged, and the market can still strengthen under the support of profitability. For example, in the years 2011-2013 and 2015-2017, the two showed annual-level divergences.
