Likely liquidity response is bullish for small-caps, bitcoin and gold. Recent spikes in the SOFR (Secured Overnight Financing Rate) spread above Fed Funds argue there is a near-term liquidity dearth. The SOFR typically jumps around month and quarter-end periods as well as during key tax payment days (most recently 9/15). But recent moves have occurred outside of those typical events. And the spread has been trending higher since July with the trailing month average running in positive territory since mid-September. The Oct 16th spike occasioning the ZION and WAL bank bad debt exposures equaled the 10/1/24 high seen just after quarter-end and following the Fed’s 9/17/24 rate cut. But the spike last year was soon resolved whereas today the upward trend and recent return to abnormally high levels (more than 3 standard deviations above average) argues liquidity risk remains high.
What does this mean for small-cap investors? It argues increased Fed liquidity including ending QT and providing additional QE-type expansion is in the offing which is bullish. Lower than expected inflation assures at least a 25 bps cut. But with system liquidity running scarce and employment and inflation data remaining subdued, a 50 bps cut and more unconventional Fed accommodation is within the realm of reason. Should the Fed not end QT and provide liquidity, there is risk to the small-cap market.