Friday's Market Minute: Less Liquidity Translates Into More Volatility

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Financial conditions are tightening as the Fed gets ready to raise interest rates resulting in a volatile start to the year. Equities are basing in the near term and seem poised for more back and forth due to uncertainty with the economic backdrop, and potential for the Fed to over-react to surging price pressures. This was to be expected, considering Jerome Powell said himself that it is time to “steadily move away” from the current highly accommodative monetary policy. In other words, it’s time to gradually rein in excessive liquidity before the potential for wage and price inflation becomes even more problematic. 

Volatility is likely to remain elevated until the next FOMC decision in March, as investors sort out the magnitude and impact of tighter financial conditions to come. When there is less liquidity in the system, there is more risk while at the same time there is less risk-taking activity. Concerned investors are buying lower-risk and highly liquid forms of narrow money like short term Treasury bills invested through money market funds. The longer the market environment becomes more bearish on a sustained basis, confidence erodes due to the diminished wealth effect. The mood of the market does have a lagged impact on the real economy, and unless the upcoming jobs or inflation data is weaker than expected, the market will have a tough go at a sustained market rally. From a tactical perspective, messaging from the Fed or economic data providing confidence that the Fed tightening will not meet or dramatically exceed current market expectations is what the bulls are eagerly waiting for.

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This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.