Morning Notes — Catalyst Ahead
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.
Morning Notes — Favorable Risk-Reward
Inflation breakeven yields tend to lead equities and Fed expectations during periods of elevated inflation.
Morning Notes — Inflation, Recession and the SPX
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.
Morning Notes — Inflation Breakeven Yields
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)
Morning Notes — Key Cross Markets
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.
Morning Notes — Fed Expectations
Markets are currently pricing in 50bp hikes in June and July and 50/50 probability for 50bps or 25bps in September. The Fed kicks off QT today with markets assuming its balance sheet on longer-dated assets will shrink by $1T by the end of 2023.
Morning Notes — Near-Term SPX Targets and the Energy Sector
We initiated positions in the Energy sector more than 9 months ago because it was inexpensive and we wanted to own ‘value’ sectors given expectations for a strong cyclical recovery.
Morning Notes — Peak Inflation Narrative
The potential bullish equity theme also requires lower levels of equity market volatility. The CBOE Volatility Index (VIX) has descended from a 5/9 peak of 34.75 to 26 today with an eventual move below 20 essentially removing the volatility headwind.
Morning Notes — Near Term SPX
At least part of the plan has come together. The challenge facing markets from late February-early May was a breakdown in normal collinearity between inflation breakeven yields, Fed rate expectations and longer-dated nominal bond yields.
Morning Notes — Nuanced Fed Pivot
Historical collinearities began to reestablish themselves after 10-year inflation breakeven yields traded below technical support at 280bps (5/9). We discussed the potential for this to happen, thinking the break below 280bps should allow terminal Fed rate expectations to fall from a peak of ~3.50% and