Markets were taken on the wrong foot by a report on the consumer price index showing generally tenacious inflation, mainly in services and rents. The sell-off wiped out most of last week’s rally based on the notion of “inflation falling, Federal Reserve peaking.” The S&P 500 is rapidly unwinding more than half of the 5%-6% pop since the start of last week, which was based on oversold conditions, pessimistic sentiment and growing hope – now postponed from at least least a month – that the main inflation indicators were looking more benign and would lead to a friendlier CPI print and therefore bring the end of Fed tightening closer. The result is a hash of upset rallies and support to higher lows, a range (3,900 to 4,200) where most of the summer has been in a wider range and with trendlines convergent. Unresolved is an understatement. At the lower end of the range an economic soft landing is assigned a low probability, at the higher end it seems like a better bet. Bonds were immediately and violently repriced to add another quarter point of Fed rate hikes before they peak above 4% early next year, with at least a slight chance of a full one percentage point increase next week rather than the likely likelihood of a 0.75 percentage point increase. The obvious concern is that the Fed will have to do much more to slow the economy, soften overall wage levels and wage growth, and tighten financial conditions to bring inflation back to an acceptable path. Has the market abused the possibility that the Fed could soon take a break with inflation ebbing on its own even as central bank speakers warned they saw no break coming ? Not really. On the one hand, high and falling inflation is one of the most bullish backdrops for equities, historically. Many key inflation drivers (including used cars, energy, airline tickets and quoted rents) have eased, as have market-based inflation expectations revealed by surveys . Markets took advantage of this to bring an oversold stock market higher in the CPI print. Not much more to say. Fed officials have been resolute in calling for tighter policy, for an extended period, and need several months of better data before pivoting. But they definitely have to say it at this point, and will say it until the market realizes they’re really done (which may or may not happen when the economy crashes and/or a capital markets occurs). The 3-month/10-year treasury yield curve has compressed further, with market prices for short-term rates rising further by the end of the year. (Interestingly, the market still sees the Fed reaching terminal rate levels around April – a higher plateau but reached in around six months). The inversion of the 3-month/10-year curve is the Fed’s preferred pre-recession indicator. It hasn’t reversed yet. In the previous three cycles, this reversal occurred between six and 18 months before the onset of the recession. Technology and growth are suffering the consequences, as usual: higher valuations, greater sensitivity to risk aversion pressures and cash flows less tied to the high levels of nominal GDP generated by high inflation . Mega Tech remains “the stock exchange, only an amplified version”. META is an interesting exception in terms of valuation (optically quite cheap) and enjoys very low investor sponsorship. Narrow multi-month range near the lows, now testing the low end. The market breadth is pretty bad: 90% drop in NYSE volume. This somewhat negates the strong breadth push signals from the recent low near 3,900 in the S&P 500, but again, it remains a range trade operating with a higher low from the mid- June. The VIX rose quite a bit in yesterday’s equity rally before the CPI catalyst, so today it is up less than two points, below 26. There is a general level of high worry. The clues are back to a familiar place, and no real panic or cover emergency.
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