$450B Floods In, Will Short Covering Ignite US Stocks Further?

Last month saw a surge in capital flowing into U.S. stocks, reaching a high not seen since March 2022. As concerns over economic recession fade, a massive short covering is imminent, leaving room for further growth in U.S. stocks?

With worries about an economic downturn dissipating, U.S. investors funneled more money into the stock market in June than in any month since March 2022.

Data from Bank of America (BofA) shows that by the end of June, the inflow of funds into the stock market had swelled to $45 billion.

The significant allocation to the stock market contrasts with the pattern of the previous six months. During that period, investors, fearing a potential economic downturn, shifted from stocks to bonds.

"Although bond yields remain attractive, concerns about recession are easing," said strategists at Bank of America.

"The S&P 500 has risen by 9% since the end of April, which is highly attractive to investors, leading to $45 billion flowing into equity funds or ETFs (Exchange Traded Funds) in June."

After a poor performance in 2022, the S&P 500 has soared by 19% year-to-date, driving short covering in the stock market.

JPMorgan and Goldman Sachs reported to clients that global hedge funds are unwinding bets against a decline in U.S. stocks, as the sustained rally threatens their performance.

Goldman Sachs stated in a report last Friday that short covering for so-called U.S. macro products, including stock indices and ETFs, has reached the highest level since November 2020. Such short covering could, in turn, drive the stock market higher, further complicating the situation for remaining short sellers.

For most of the past year, the market has been bracing for a recession as the Federal Reserve has worked to control high inflation through interest rate hikes.At present, inflation has dropped close to the Federal Reserve's 2% long-term price target, but the US labor market remains robust, which may make it more likely for the economy to achieve a soft landing.

Last month, US housing prices rose by 3%. After the release of the June inflation report, the cooling inflation data drove a weekly inflow of $12 billion.

At the same time, investors expect the Federal Reserve to soon pause interest rate hikes and even start cutting rates, as inflation seems to be steadily declining.

According to the CME's Fed Watch tool, the market expects the Federal Reserve to raise interest rates by 25 basis points in July, and there is an 86% chance of pausing interest rate hikes in September.