Trend Changes in the U.S. Capital Markets

On May 9, the U.S. stock market appeared to slump after falling continuously for a week. On that day, the S&P 500 Index fell 3.2%, the Nasdaq Composite Index was down 4.3%, and the Dow Jones Industrial Average dropped 2% to close at its lowest level since November 2020. The oil and digital assets also declined sharply on the same day.

For now, the biggest impact on capital markets remains caused by the accelerated Federal Reserve’s tightening of its monetary policy. Rising interest rates and an imminent balance sheet reduction have led to a major correction in risk asset valuations. Meanwhile, the Fed’s inflation-control policies are signaling to forego the dollar liquidity needed to sustain capital market bubbles.

The Nasdaq 100 has been facing technical challenges in the stock market for weeks. Meanwhile, the S&P 500 has been down 16% this year. The performance of a Goldman Sachs-tracked basket of stocks popular with retail investors has deteriorated even worse (fallen 36% since January). Technology stocks have also been hit particularly hard this year. This situation occurs due to rising interest rates, which have likely influenced asset prices connected to future earnings.

The sharp rise in U.S. Treasury yields means that the bond market is also experiencing a sell-off, sparking a simultaneous sell-off in stocks and bonds. As ANBOUND pointed out early this year, the U.S. stock market is seeing a trend shift, because of changes in the Fed’s monetary policies. The trend adjustments in the U.S. capital markets are unavoidable in this new environment.

Investors in the U.S. capital market are concerned about two matters. First, the changes in inflation, and second, the restraining effect of tightening policies on inflation. They are also concerned with the latter’s adverse impacts on the U.S. economy. According to ANBOUND researchers, the U.S. economy’s ability to sustain such dramatic currency changes in the future may be in doubt.

The Fed’s continued monetary tightening may not protect capital markets from volatility and risk, as it did in 2018. The current trend shows that the monetary tightening might lead to a shrinking capital market bubble.

At present, major market institutions appear discouraged by the U.S. stock market’s trend. Meanwhile, Credit Suisse has lowered its forecast for the S&P 500 Index. Goldman Sachs, Bank of America, and Morgan Stanley also expect the stock market to slow down this year.

For the United States, the development of financial markets is arguably closely linked to the growth of the U.S. economy. Goldman Sachs believes that financial conditions would have some impact on the country’s future economic growth. According to the institution, every 100-basis point increase in its Financial Conditions Index (FCI) will result in a one-percentage-point slowdown in the U.S. economy during the following year.

Sven Jari Stehn, Goldman Sachs chief European economist, said the bank’s U.S. FCI needs to be tightened further to achieve a “soft landing”. This attempt means slowing growth but not too much. Stehn added this effectively requires to slow growth to approximately 1% for a year or two in order to get below trend for a year or two. This explanation shows how difficult it is for the U.S. economy to strike a balance between economic growth and inflation control.

Inflation has long been a perplexing concern that has harmed the U.S. economy and its capital markets. Since the unlimited quantitative easing in 2020, the U.S. capital market has swelled to a record high, supported by abundant liquidity. However, it is still some distance away from the pre-pandemic period.

If the current trend continues, inflation will endanger not only the stability of the U.S. capital market but also the real economy. The Fed’s competence to withstand the unprecedented pressure is the focus of the market. This is also a key point in determining whether the capital market could turn things around.

The adjustment in the U.S. capital market may not be good news for other countries that rely largely on capital inflows. The predominance of U.S. dollar capital clearly shows one sign. International capital is expected to return quickly to the U.S. market in a similar fashion as during the COVID-19 pandemic in 2020.

It happens because of the liquidity gap caused by the continued downturn in the U.S. market. This situation is bound to further exacerbate the outflow of funds from Japan, Europe, and emerging markets. As a result, it would generate a new round of volatility in global markets.

Final analysis conclusion:

There is a highly noticeable change in trends taking place. The ongoing expansion of capital market bubbles since the COVID-19 epidemic has been marked by increased volatility in the U.S. stock market. Changes in U.S. inflation and the Federal Reserve’s monetary policies are also causing this pattern to shift, resulting in a fresh round of volatility in global markets.

Writer by Wei Hongxu
A researcher at ANBOUND, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham, UK

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ANBOUND is a multinational independent think tank, specializing in public policy research, incl. economy, urban and industry, geopolitical issues. Est. 1993.

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ANBOUND is a multinational independent think tank, specializing in public policy research, incl. economy, urban and industry, geopolitical issues. Est. 1993.