According to Citigroup Inc, equities and other risk assets are expected to suffer as central banks prepare to withdraw up to $800 billion in stimulus that has propped up the global economy.
The Role of Central Bank Liquidity in Fueling the Risk Rally
The risk rally has been primarily driven by the infusion of more than $1 trillion in central bank liquidity. However, Matt King, Citi’s global markets strategist, reports that high-frequency liquidity indicators already show signs of stalling.
In addition to monetary support from other central banks, the Federal Reserve has expanded its balance sheet by $440 billion following the US banking crisis.
This concerted global policy support has maintained low real yields, elevated equity multiples, and tightened credit spreads despite falling earnings expectations, King explains.
The Unwinding of Support: Shifts in Central Bank Policy
As China’s central bank begins to curtail its easy policy settings in light of strong growth, its US and European counterparts are expected to revive quantitative tightening measures, according to King.
In a recent appearance on Bloomberg’s Odd Lots podcast, King stated that “stealth” quantitative easing from global central banks has been responsible for the market’s exuberance.
“We now expect almost all of them to stall or go into outright reverse. We think this could subtract $600 billion — $800 billion in global liquidity in the coming weeks, undermining risk in the process,” King wrote in a note. “With peak liquidity past, we would not be surprised if markets were now to experience a sudden pressure loss,” he added.
Skepticism Surrounding the Risk Rally Following Stimulus Dropoff
King’s perspective comes as US stocks have risen 8.2% this year, buoyed by a 36% increase in the NYSE FANG+ Index due to a surge in tech stocks. In addition, Bitcoin, often viewed as a risk barometer, has nearly doubled in value since the end of December.
Others in the financial industry have also expressed doubts about the risk rally. Nick Ferres, Chief Investment Officer for hedge fund Vantage Point Asset Management, believes equity market pricing is excessively optimistic.
“Market breadth supporting the rally has been extremely poor,” Ferres commented in a recent note. “Equity investors appear to want all the benefits of rate cuts without enduring the pain that would warrant them.”
As central banks worldwide start to scale back their stimulus measures, it remains to be seen how the markets will react to the withdrawal of liquidity. As a result, investors must keep a watchful eye on these developments and adjust their strategies accordingly.