"Excess liquidity" turns negative; U.S. stocks may face the strongest headwind since 2021.

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While the U.S. stock market is still reveling in the AI craze and the endless record-breaking of tech stocks, some key macro indicators are sounding the alarm.

Bloomberg strategist Simon White recently wrote that the global financial environment is entering a new round of tightening. Excess liquidity has turned negative for the first time since 2021, the yield curve continues to flatten, and real interest rates keep rising, all indicating that the main drivers supporting risk asset gains over the past few years are gradually disappearing.

Although the new Federal Reserve Chair Kevin Warsh’s inaugural FOMC meeting has sent out a hawkish signal, the market had actually tightened ahead of time. The bond market is continuously pricing in higher rates, and financial conditions have seen their most significant tightening since the post-pandemic inflation shock.

Excess liquidity turns negative, market adjustment risks are building

Simon White’s key metric is “excess liquidity,” which refers to the remaining growth in money supply after subtracting inflation and economic growth.

In recent years, a loose monetary environment has provided ample support for the stock market, but now this indicator has turned negative and continues to decline. As economic growth recovers and inflation resumes, the incremental funds brought by monetary expansion are being quickly depleted.

Historical experience shows that a decline in excess liquidity usually causes the yield curve to flatten, and puts pressure on stock market performance over the next 3 to 6 months. Meanwhile, the current relative valuation of stocks and bonds is near the 95th percentile of the past fifty years' historical distribution, meaning that even just mean reversion could trigger stock market adjustments and further changes in bond yields.

Narrowing interest rate gap, implicit global monetary tightening intensifies

White argues that the key to judging whether monetary policy is restrictive lies in the gap between policy rates and neutral rates.

Although the market generally believes that the AI capital expenditure boom has raised the neutral rate, terminal rate expectations are rising even faster, causing the gap between the two to continually narrow. This means monetary policy is becoming increasingly restrictive.

Globally, this trend is also evident. As inflationary pressures from war spread worldwide, central banks have shifted back to hawkish stances, and the market’s expectations for future rate hikes and prolonged high interest rates continue to intensify. Models show that global long-term real rates still have room to rise further in the coming months, and the financial tightening process is far from over.

Liquidity ebb compounded by supply expansion puts pressure on stocks

For the stock market, the more tricky issue compared to interest rates is that liquidity is fading at an accelerated pace.

Historical data shows that excess liquidity has a strong correlation with future stock market returns, and continued liquidity deterioration is often accompanied by weak risk asset performance. Currently, not only is liquidity shrinking, but stock supply pressure is also rising—the net stock supply in the U.S. has turned positive for the first time since the pandemic, with corporate financing, additional share issues, and IPOs rebounding, meaning the market must absorb more new shares.

In an environment of insufficient liquidity, supply expansion directly increases valuation pressures. Simply put, the market will not only face fewer funds, but also more assets competing for limited capital.

AI craze can’t mask liquidity concerns; sentiment-driven rallies must face funding realities

What deserves attention is that there is now a clear divergence between market sentiment and liquidity conditions. Data show that U.S. equity ETFs have recently recorded the second highest one-month inflows in history, with a surge of retail investors returning to the market, betting on continued gains for tech and AI-themed stocks.

Historically, retail investors tend to be the most active buyers during the final stages of a bull market. As more funds chase returns in the late stages of an upswing, the market often enters a sentiment-driven phase of accelerated gains, but this prosperity itself signals the accumulation of risk.

In White's view, the real challenge now is not an economic recession, but the contradiction between ongoing liquidity contraction and elevated valuations. The AI boom may still provide a short-term emotional boost, but if the liquidity supporting risk assets continues to disappear, the stock market will ultimately face a much tougher test.

Risk Disclosure and DisclaimerThe market entails risks; investments require caution. This article does not constitute personal investment advice, nor does it take into account individual users’ specific investment objectives, financial circumstances, or needs. Users should consider whether any opinions, views, or conclusions presented here are suitable to their personal situation. Investments made based on this article are at the user's own risk. ```