Fed Love-Hate Relationship With Liquidity Injections Pushes S&P 500 To New Record High on Valentine's Day

The U.S. Federal Reserve has something of a love-hate relationship with its latest liquidity injection policy. The Fed keeps having to supply money markets with more and more liquidity, which has contributed to boosting the S&P 500 (Index: SPX) to four new record highs in the last week, but Fed officials are signaling they really want to stop.

That may be why investors appear to now be focusing strongly on 2020-Q4 in setting today’s stock prices, as suggested by the dividend futures-based model that underlies our alternative futures spaghetti forecast chart for stock prices:

This brings us to something we missed in the data in the previous edition of our S&P 500 chaos series, where we took a cautious note in reading the week’s data:

This is where we have to add a note of caution, because we’re dealing with a rapidly evolving situation in the markets. If you look at the alternative futures chart above, if investors shift their attention fully toward 2020-Q3 in setting current day stock prices, the S&P 500 could continue to rise by as much as 250-300 points. But, if China’s and the Fed’s liquidity injections work to stabilize markets as intended, the FedWatch tool’s probability estimates may only have caught investors in the process of shifting their focus more fully back toward 2020-Q4, which is consistent with the S&P 500′s recent trajectory, which would also mean that stock prices are within a few percent of where they might go.

What we missed is that the reason investors would now be fixing their focus more tightly on 2020-Q4 in setting current day stock prices is because they are betting that this distant future quarter will see the Fed cut short term interest rates for a second time in 2020. According to the CME Group’s FedWatch tool, investors are now giving a 46% probability they will follow a quarter point rate cut in 2020-Q3 with another in 2020-Q4.

Consequently, unless the arrival of new information leads investors to alter that expectation, we think the liquidity operations that Fed officials hate will be with us for quite some time longer than they would like.

In any case, here are the more significant market-moving headlines we found in the past week’s news stream:

Monday, 10 February 2020

• Oil drops to 13-month low on weak Chinese demand, traders eye OPEC+ cuts
• Coronavirus could trim 1 percentage point from China GDP growth: government researcher
• Fed minions speak on interest rates, inflation, coronavirus impact:

• Fed’s Harker says central bank should hold rates steady for a while
• Harker says Fed may need to act if coronavirus takes toll on U.S. economy, but not yet
• Fed’s Daly: Inflation is ‘far better’ a bit above target than below
• Fed’s Daly: Limited impact from new China coronavirus on U.S. economy

S&P 500, Nasdaq reach record closing highs; Chinese workers return

Tuesday, 11 February 2020

• Oil prices rise about 1%, up from 13-month low as virus cases slow
• U.S. job openings hit two-year low, point to slowdown in job growth
• Bigger trouble developing from impact of China’s coronavirus epidemic:

• Trump’s national security adviser says coronavirus could impact U.S.-China trade deal: CNN
• China firms cut staff on virus outbreak as Xi vows no large-scale layoffs
• Xi warned officials that efforts to stop virus could hurt economy: sources

Fed minions speak on monetary policy, virus impact:

• Fed’s Kashkari says monetary policy is not very accommodative
• Bullard: Fed’s policy message ‘blurred’ by actions in short-term markets
• Fed’s Bullard: China to ‘slow noticeably’ in first quarter due to virus

S&P 500, Nasdaq eke out new closing highs

Wednesday, 12 February 2020

• Oil rises over 3% as demand worries ease amid fewer new coronavirus cases
• Bigger trouble developing all over:

• Coronavirus likely to hurt euro zone, UK growth: S&P Global

Bigger stimulus developing in China, U.S.:

• China takes major steps to prop up coronavirus-hit economy
• Fed Injects $79BN In Liquidity: Term Repo Most Oversubscribed Since Repo Crisis

Fed minions speak from new confidence-building script:

• Fed Chair Powell: ‘no reason’ rising wages, job gains can’t continue

• Powell Admits ‘Low Rates Are Not A Choice Any More’, Says QE Will Be Used In Next Downturn

Fed’s Daly says U.S. economy well placed to weather storms

Stocks gain as China says fewer new coronavirus cases

Thursday, 13 February 2020

• Oil prices climb on prospects for deeper OPEC+ output cuts
• Bigger trouble developing in China:

• China’s Hubei province sees surge in coronavirus deaths on switch to new methodology
• S&P Global gives China rating warning over virus spending splurge
• China auto sales likely tumbled 18% in January, coronavirus seen taking heavy toll

Bigger stimulus developing in China, Taiwan, Mexico:

• Chinese companies tap ‘virus bonds’ to raise billions quickly
• Taiwan plans $2 billion package to soften coronavirus hit to economy
• Flagging weaker growth, Mexico central bank cuts interest rate again

Taking the liquidity punch bowl away?

• New York Fed to further reduce repo support

Wall Street slips as coronavirus fears mount

Friday, 14 February 2020

• Oil rises over 1% on hopes demand will rebound from coronavirus effect
• Bigger trouble developing everywhere:

• German economy ‘flirts with recession’ as fourth-quarter output stagnates
• Singapore PM says recession possible due to coronavirus outbreak
• Japan’s exports, machinery orders seen falling as virus risks grow: Reuters poll
• Chinese economy clobbered by coronavirus but set to recover soon: Reuters poll
• Electric shock: China power demand drops as coronavirus shutters plants
• U.S. January industrial output falls on weather, Boeing drop

Bigger stimulus developing everywhere:

• 800 rate cuts on and investors throw money at everything: BofA

Fed minions having trouble staying on new “all is well’ messaging:

• New York Fed’s Williams sees economy in ‘very, very good place’
• Fed’s Mester says China virus could drag on U.S. economy

S&P 500, Nasdaq gain on Nvidia, White House stock incentive report

• Trump administration eyes 10% middle-class tax cut proposal

Over at the Big Picture, Barry Ritholtz succinctly summarizes all the positives and negatives he found in the past week’s economics and market-related news.