Morning Notes

Inflation expectations drive Fed rate expectations, and hawkish Fed expectations are weighing on the S&P 500 (SPX). Ten-year inflation breakeven yields are still the best measure of inflation expectations.

Bond markets are now priced for 75bp tomorrow, 75bp for July, 50bp for September, 50bp for November, 25bp for December and 25bp for February ’23. Altogether, that’s 300bp of rate hikes and if that’s the destination, equity markets would prefer to get their sooner rather

Decelerating inflation and slower growth should weigh on value stocks more than quality. Year-to-date, the S&P 500 Value Index is outperforming the S&P 500 by 930bp.

The S&P 500 should remain above technical support at ~3,850 as long as 10-year inflation breakeven yields remain below 283bp.  

Our primary focus for equity markets are 10-year inflation breakeven yields, which currently sit at 277bp.  

The trigger for an SPX reversal in March 2020 was narrowing credit spreads. We accurately identified the trigger in early March with the event occurring 2 weeks later on 3/23/20.  

Inflation breakeven yields tend to lead equities and Fed expectations during periods of elevated inflation.

A new paper from the Fed contrasts the inflation from the ‘70s to the current situation, suggesting policymakers from the 70’s didn’t fully understand how monetary policy effected prices until Paul Volker arrived at the Fed in 1979.

The S&P 500 (SPX) has already absorbed the assumed tightening in monetary policy.  Inflation expectations will need to rise in order for the Fed to do more.  Base effects make the peak inflation narrative a virtual certainty and leading indicators on PPI inflation (based metals)

The relationship between inflation breakeven yields and terminal Fed rate expectations is the most important cross market indicator for equity investors given concerns for a Fed policy mistake.