Inside Markets — Inflation Easing

Inflation has been easing with headline numbers near +2.5% and likely on the way to +2% given favorable base effects from seasonal adjustment factors. The labor market has been weakening with the Unemployment Rate now at 4.25%, so there’s no real reason for a 5.3% Fed funds rate. Labor market data will be the biggest input ahead of the Fed’s September meeting. The Fed can wait and respond to every monthly Jobs Report as they print or be a bit more proactive to head off further weakening. Given the 5.3% starting point and ~4% neutral rate (actually a bit lower than that), we’d expect the committee will choose the proactive route and engage in an easing cycle rather than a couple of 25bp cuts. We also expect Powell will do what it takes in response to weakness, which should translate to yield curve steepening.

In the near-term, expect 2-year Treasury yields to find resistance in the 4.12-4.20% range over the next several weeks. Taking a step back, we see 2-year yields at the upper end of a multi-year top with some support near 3.60% before breaking lower to ~2.90% as the move accelerates in 2025. Any counter trend back up in 10-year yields would likely fade on the approach to the 4.05-4.14% range. A break below 3.65% later this year should open the door for a move to 3.23% in ’25.

The 5-year/30-year yield curve is now trading at +37bp with resistance near +59bp and support in the 28-32bp range. The current period of consolidation looks like a bullish set-up for an eventual aggressive steepening in the months ahead.

We abandoned our tactically bearish outlook on the SPX break above the post-payroll downside gap at 5447. The VIX has quickly returned to levels from mid-July which opens the door to systematic/hedge fund and passive position re-grossing. Cyclical and small cap stocks are still well off highs and short-term oversold. These groups would have the most to gain from a Fed easing cycle.