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Markets were caught off guard by the CPI report showing generally stubborn inflation, mostly in services and rents. The sell-off wiped out most of last week’s rally based on the notion of “falling inflation, peak Fed aggressiveness.” The S&P 500 is rapidly spinning off more than half of the 5% to 6% gain since the start of last week, which was based on oversold conditions, pessimism and growing hope – now delayed by at least a month – that inflation leading indicators look more benign and lead to to a more favorable CPI print and therefore bring the end of the Fed’s tightening closer. The result is a mixture of derailed rallies and support at higher lows, a range (3900 to 4200) where most of the summer was spent in a wider range and with converging trendlines. Unresolved is putting it mildly. At the bottom of the range, an economic soft landing is considered a low probability, at the top it looks like the best bet. Bonds are immediately and sharply revalued to add another quarter of a point to the Fed’s rate hike before they peak above 4% early next year, with at least some small chance of a full percentage point hike next week, not a probability. with an increase of 0.75 percentage points. The clear concern is that the Fed will need to do much more to slow the economy, ease aggregate wages and wage growth, and tighten financial conditions to bring inflation back on a sustainable path. Has the market been delusional in assessing the likelihood that the Fed may soon pause as inflation eases on its own, even though central bank speakers have warned they see no pause ahead? Not really. First, high and falling inflation has historically been one of the most optimistic backgrounds for equities. Many of the leading drivers of inflation (including used cars, energy, airfare and advertised rentals) have declined, as have market-based inflation expectations and polls. The markets seized on this to push the oversold stock market higher into the CPI stamp. There is nothing more to say. Fed officials have been strongly calling for more restrictive policies for a long time, and they need more accurate data months before they change. But they absolutely have to say it at this stage and will say it straight up to the point where the market realizes they are really done (which may or may not happen when the economy collapses or the capital markets crash). The 3-month/10-year Treasury yield curve tightened further as short-term market price rates rose further towards the end of the year. (Interestingly, the market is still seeing the Fed hit rate caps in April or so – a higher plateau but reached within six months or so.) The 3-month/10-year curve inversion is the Fed’s preferred pre-crisis indicator. He hasn’t converted yet. In the previous three cycles, this reversal took place between six and 18 months before the start of the recession. Technology/growth, as usual, takes the brunt: higher valuations, greater susceptibility to risk aversion pressures, and cash flows less tied to the high nominal levels of GDP that higher inflation generates. Mega Tech remains “the stock market, just a boosted version.” META is an interesting exception in terms of valuation (optically quite cheap) and has very little investor sponsorship. Narrow multi-month range near the lows, now testing the lower limit. The breadth of the market is rather unpleasant: 90% of the volume on the NYSE is lower. This somewhat cancels out the strong extension signals from the recent floor near the 3900 S&P 500, but again it remains range trading, operating from a higher low from mid-June. The VIX rose slightly during yesterday’s rally in stocks ahead of the CPI catalyst, so it is up less than two points below 26 today. There is a general heightened level of concern. The indices are back in a familiar place and there is no real panic or hedging urgency.
Credit: www.cnbc.com /