Morning Notes

The biggest overhang for equities has been central bank policy and a shift in tightening expectations will remove the overhang.

US core PCE (Fed’s preferred inflation measure) came in cooler than expected, up +0.3% MoM vs. consensus for +0.5%.  This is the third-consecutive monthly decline in core PCE and the lowest level since January.

The forward curve is pricing in a decline in headline inflation and we expect lower goods prices H2’22.  Energy prices will likely remain elevated and could rise further based on underinvestment and refining capacity.

Ten-year Treasury yields and risk markets (copper/gold ratio, European equity indices, semiconductors and US Financials) tend to have a positive correlation.  That correlation broke down after the 2/24 invasion caused 10-year inflation expectations to overshoot in the face of hawkish Fed rhetoric.

The 4200 level is a significant technical challenge and pushing beyond the range will likely require a change in macro fundamentals, specifically realized inflation.

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.