El-Erian: Are Stocks Losing Some of Their Liquidity Momentum?

The volatile market action over the past 24 hours shines a spotlight on an important question for investors: Have markets lost part of the liquidity anchor that not only allowed them to brush off a number of negative influences but also pulled stocks higher to one record after the other? The issue becomes all that more important given the continued uncertainty facing the fiscal relief package and Thursday’s jobless claims numbers.

Going into the Federal Reserve’s statement and press conference on Wednesday, there were already signs of less reliable price support from what had been a highly influential inflow of retail investors. Its impact, while still notable, has been shrinking gradually from the broader market to a narrowing set of specific companies.

Despite this, skeptical investors’ appetite to challenge what they regard as elevated valuations remained repressed by their experience with, and respect for, ample and repeated Fed liquidity injections. And it wasn’t just because the Fed has been keeping the cost of leverage and borrowing very low, has been buying trillions of dollars of securities (including higher-risk junk bonds) and has been pushing investors from government bonds into higher-risk assets. The Fed’s repeated support for financial markets has engendered a deep “buy-the-dip” investor conditioning and a prominent FOMO mindset.

Although the Fed did deliver again for riskier assets with a more dovish-than-expected policy statement on Wednesday, the markets’ feel-good reaction evaporated during the press conference that followed. Several reasons have been cited for this, including the cautionary tone taken by Chair Jerome Powell and the way he addressed the prospects for fiscal policy. They also include his seemingly tentative responses to questions on the effectiveness of the central bank’s tools to meet the de facto more ambitious inflation target, on the contrast between the specificity of the outlook for interest rate policy (high) and asset purchases (low), on the challenges facing the Main Street Lending Program and on the outlook for financial stability. This adds to the long-standing concern that the more dovish the Fed is, the less likely lawmakers in Congress will agree on a new relief package.