Liquidity can be defined as available cash or capital that can be used to purchase goods and services. Liquidity enables assets to be bought or sold with greater ease as the cash or capital needed to purchase those assets is readily available. Illiquidity generally results in assets selling with much more difficulty as there isn’t as much cash or capital available to prospective buyers.

High liquidity is a very desirable state as it facilitates purchases and sales, which usually leads to higher prices. We’ve been in a state of high liquidity for a number of years which has certainly been a tailwind for asset prices like stocks and houses. Liquidity hasn’t been the only driver of asset prices during the past decade or so but it has certainly helped.

With a Federal Reserve intent on reducing liquidity and a potential shift in power in Congress to a less liquidity friendly party, at least with the current administration, it’s not unreasonable to be somewhat concerned about asset prices going forward. Again, liquidity isn’t the sole driver of asset price appreciation but it provides a nice assist. So, what happens if the Fed tightens (reduces liquidity) and the Republicans take control of the Senate and turn off the liquidity spigot? It’s hard to say but the lack of a tailwind will make price increases harder to come by and asset markets will likely be choppier.

This may all be a moot point if the Fed doesn’t end up tightening and if the Democrats retain control of Congress. However, market participants are already handicapping these scenarios and positioning themselves according to the likelihood of each one. The other wildcard is the economy. If it can maintain its footing and continue to grow then a reduction in liquidity may end up being a non-event after all. That is probably the most ideal situation, but I’m not sure how likely it is to occur.