S&P 500 Liquidity Drained by Prolonged Shutdown

S&P 500 Digests Earnings Reports

The sentiment and direction of the S&P 500 last week were clearly downward.

Market optimism throughout the week was negative as doubts about a December meeting cut to interest rates gained momentum.

At the opening of markets on Friday, there was clear evidence of institutional selling. The sharp drop in the University of Michigan’s Consumer Confidence index was no surprise, given that the sentiment index was already deep in the fear zone.

The markets, however, closed nearly unchanged as optimism around U.S. government shutdown negotiations improved.

While markets were not significantly impacted by the U.S. shutdown in October, this will change as more governmental services and sectors are affected.

Liquidity Crunch  

The S&P 500 is experiencing its worst start to a month since the Liberation Day announcement in April.

That in part reflects a liquidity crunch that is becoming more evident (around $700 billion of liquidity has been drained from the markets in the last 30 days) as the government shutdown continues.

While the government may be shut down, it is still taking money in. However, the freeze on government spending means the Treasury General Account (TGA) stalls, effectively locking liquidity out of the system.  

If the shutdown extends much longer (online betting markets suggest it is likely to end by mid-November, though odds are increasing that it will extend), the weight of probability suggests a significant market correction is likely. 

Market Correction

Markets have been lopsidedly bullish since the Liberation Day correction, and the lack of Trump commentary on the current market correction suggests the administration is happy to see some air come out of the market.

Markets don’t normally top when earnings are strong, however, a correction could be triggered by the FED not cutting interest rates in December or further deterioration in the repo market.  

On the flip side, when the shutdown ends and the government reopens, the markets will likely experience positive momentum to the upside.

Looking forward, increased volatility in markets will likely continue as the Supreme Court decision on tariffs and the change in FED Chair loom large on the horizon.