The previous article sorted out the economic data for everyone, so how to read the economic data, what data is good, what data is bad, why the data is sometimes good, sometimes bad? This chapter on market expectations will analyze the analysis logic behind the data.


5. Market expectations

The performance of asset prices is driven by market expectations, and the fundamental force that affects asset price changes is liquidity. The core of market expectations lies in the prediction of future liquidity changes. Liquidity can be divided into two categories: short-term liquidity and long-term liquidity, which are determined by policy changes and economic growth respectively. This is also the reason why bad news is good news when trading interest rate cuts this year, and bad news is bad news when trading recessions.

5.1 Asset Prices and Liquidity: The Core of Market Expectations
Liquidity refers to the availability of funds in the market. The rise in asset prices depends on the abundance of liquidity. Conversely, when liquidity is tight, funds withdraw from the market and risky assets are under pressure. Therefore, the essence of market expectations is investors' predictions on future liquidity changes, that is, predictions on policy expectations and economic changes.
Short-term liquidity: controlled by monetary policy and fiscal policy. The central bank adjusts the supply of funds in the market through interest rate hikes, interest rate cuts, quantitative easing or tightening, while the government's fiscal spending and tax policies directly affect the flow of funds in the market.
Long-term liquidity: Determined by economic growth. When the economy expands, corporate profits and revenues increase, and market liquidity becomes more abundant; when the economy is in a downturn, liquidity decreases and asset prices face pressure.

5.2 Market Expectation Analysis: Good News and Bad News in the Detailed Cycle
Based on the following four detailed cycles - the early stage of tightening to easing, the easing period, the early stage of easing to tightening and the tightening period, combined with the short-term liquidity changes brought about by policy expectations and the long-term liquidity changes brought about by economic growth expectations, this paper analyzes the good news and bad news at different stages and their impact on the market.

a. Early stage of transition from tightening to easing: adjustment of liquidity expectations before policy shift
Situation: In the early stage of the transition from tightening to easing, short-term liquidity expectations are key, as investors focus on when the central bank will start to relax its policy (such as cutting interest rates or stopping raising interest rates). At this stage, bad news (such as weak economic data) becomes a positive because it accelerates the possibility of a policy shift and increases short-term liquidity.

Short-term liquidity: The market expects monetary policy to be relaxed soon, and short-term liquidity will increase rapidly. Weak economic data prompts the central bank to relax its policy and accelerate the injection of liquidity into the market.
Long-term liquidity: Long-term liquidity still depends on economic growth expectations. If the market expects the economy to gradually recover, long-term liquidity expectations will also increase with the economic recovery.

Market reaction:
The good news is the bad news: if economic data is strong (such as employment data that beats expectations), the market may expect that the tightening policy will continue for longer, resulting in less liquidity and lower asset prices.
Bad news is good news: if economic data is weak (such as rising unemployment), the market expects the central bank to cut interest rates or loosen policy more quickly, increasing short-term liquidity and driving the market higher.

b. Loose period: economic expansion and abundant liquidity go hand in hand
Situation: During the easing period, the central bank has clearly adopted an easing monetary policy, the short-term liquidity in the market is relatively abundant, and investors begin to focus on long-term economic growth expectations. At this stage, economic growth expectations dominate the market, and if economic expansion data continues to be strong, long-term liquidity expectations will also be strengthened.

Short-term liquidity: As policies have been loosened, short-term liquidity is abundant, driving the market upward.
Long-term liquidity: The market pays attention to the actual performance of economic growth. If the economic recovery is strong, long-term liquidity expectations will increase and market sentiment will be more positive.

Market reaction
Good news is good news: strong economic data (such as GDP growth and employment recovery) indicate that policy effects are evident, economic expansion is going smoothly, and the market expects that long-term liquidity will continue to improve and asset prices will rise.
Bad news is bad news: If economic data is weak, the market may begin to question the effectiveness of loose policies and worry about long-term economic growth prospects, which in turn will affect long-term liquidity expectations and lead to market declines.

c. Early stage of transition from easing to tightening: Expectations of liquidity tightening are formed
Situation: When the loose policy is coming to an end and the market expects the central bank to turn to tightening, short-term liquidity expectations begin to tighten. At this time, investors begin to pay attention to inflationary pressure or economic overheating signals in economic data, and short-term liquidity expectations gradually turn to tightening.

Short-term liquidity: The market expects that liquidity supply will gradually decrease in the future, resulting in a decline in short-term liquidity.
Long-term liquidity: If economic data still shows expansion, the market may remain optimistic about long-term liquidity, but be more cautious about short-term liquidity.

Market reaction
Good news is bad news: strong economic data (such as rising inflation and a hot job market) may accelerate the central bank's interest rate hike plans, reduce short-term liquidity, and the market reacts negatively.
Bad news is good news: if economic data is weak, the market may expect the central bank to delay tightening, short-term liquidity will continue to be maintained, and the market will rebound.

d. Tightening period: liquidity tightens, and the market focuses on signals of policy easing
Situation: During the period of tightening policy, the central bank continued to raise interest rates or implemented quantitative tightening, and short-term liquidity decreased significantly. The market is most concerned about when policies will slow down or end tightening. At this time, short-term liquidity expectations have tightened significantly, and investors are beginning to look forward to signs of policy easing.

Short-term liquidity: Liquidity gradually decreases during the interest rate hike cycle, market funding costs rise, and risky assets come under pressure.
Long-term liquidity: The market also pays attention to economic growth data. If tightening policies begin to suppress economic growth, the market will also become cautious about long-term liquidity.

Market reaction
Good news is bad news: strong economic data (such as inflation still high and strong employment) may allow the central bank to continue tightening policy, further reducing short-term liquidity and the market falling.
Bad news is good news: weak economic data (such as rising unemployment and declining GDP) may lead the market to expect an end to policy tightening, increase short-term liquidity, and drive a market rebound.

5.3 Summary
The research on market expectations needs to focus on the core issues that the current market is trading, and clarify whether it is trading short-term policy changes or long-term economic growth. In the early stage of policy shift, the market focuses on short-term liquidity changes, and policy expectations dominate market sentiment; in the medium term when policies are stable, the market relies more on economic fundamentals, and long-term growth expectations become the core. Therefore, the key to expectation research is to identify the focus of market transactions, to judge the quality of news, and to flexibly respond to changes in liquidity and growth expectations in different periods.