2024 Economic Outlook: The Final Chapter—Three Key Risks to Surveil as Markets Push Higher | Blog

What we want you to know: US stocks continue to reach new highs, how long can the current bull market continue? Are there potential risks in the market being overlooked? This final chapter of the 2024 economic outlook will outline the three key risks to the year and breakdown the latest developments.

Since the beginning of 2024, the three major US indices (Dow Jones, S&P500, Nasdaq) have reached historic highs, and Taiwan's stock market is also approaching 18,000. Going forward, with the continued pullback in inflation, optimistic market expectations for interest rate cuts, and fewer concerns around a hard landing, the question arises: How long can the current economic expansion last? Are there potential risks in the market being overlooked?

In the final chapter of this outlook series, MacroMicro presents three risk factors to watch in 2024, while also providing an update on the current state of play for these factors.

Liquidity Buffers to be Depleted, Can Monetary Policy Shift to Easing in Time?

Since the beginning of the current interest rate hiking cycle, rapid increases in rates have led to a decline in bond prices, momentarily sparking a crisis among small to medium-sized banks. However, there has been no significant liquidity risk, a point we have repeatedly emphasized. The primary reason liquidity remained unthreatened in 2023 is due to the presence of excess liquidity, notably the funds released from the Federal Reserve's overnight reverse repurchase agreements (ON RRP), which played a buffering role. (Related Article: Top Ten Crucial Charts for 2024 - The First Chart)

However, if the current pace of nearly $200 billion, or even more, leaving the ON RRP each month continues, the funds in ON RRP could drop to below $600 billion. This could potentially bottom out as soon as the second quarter. Once the ON RRP is depleted, the absorption of liquidity will shift to the banking sector's excess reserves. When these reserves fall to $3 trillion, representing 10% to 12% of total assets, liquidity could be impacted. Therefore, whether the Federal Reserve can shift its policy to ease liquidity by cutting interest rates or even pausing its balance sheet reduction during Q2 becomes a critical point of observation.

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Risk Tracking: Federal Reserve to Cut Rates and Slow Balance Sheet Reduction in Q2
In a notable shift, the Federal Reserve's latest statement has omitted the phrase considering "the extent of any additional policy tightening," signaling a pivot in this year's monetary policy stance. Although a rate cut in March appears unlikely, confidence in rate reductions later in the year is growing, with the FedWatch tool now forecasting a cut of 100 to 150 basis points by the Federal Reserve in 2024. Chairman Powell, in a press conference, stated that it's not necessary to wait until the ON RRP funds are depleted to begin discussions on the pace of balance sheet reduction and the overall state of the Federal Reserve's assets and liabilities, indicating that these topics will be thoroughly explored at the March meeting. Additionally, the U.S. Treasury has announced its marketable borrowing plans for the first and second quarters of 2024, projecting a Q1 debt issuance of $760 billion—significantly lower than the previous year's $816 billion estimate. Q2 issuance is expected to decrease further to $202 billion, also below market expectations. The Treasury also announced plans to initiate small-scale buyback operations in April, with details to be released in May. We believe that if the Federal Reserve proceeds with a rate cut and discussions on slowing the pace of quantitative tightening (QT) in Q2 as anticipated, and if the Treasury complements these actions with reduced debt issuance and buyback operations, the risk of liquidity crises in the United States this year could be mitigated.

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