Inside Markets — Rotation

Fed anticipation is driving an ongoing rotation into cyclical/value sector. Market pricing for a greater likelihood of a 50bp rate cut on Wednesday has resulted in a more intense rotation this morning. Wednesday’s rate decision is important, but so is the updated SEP and dot plot given nearly 250bp of total cuts priced into OIS forwards. Cyclical/value sectors and small cap stocks should continue to work higher from here if the US economy is able to avoid a recession.

Markets are also priced for a soft economic landing with tomorrow’s retail sales the most closely watched datapoint in weeks. The SPX was able to completely recover its August 2 losses (post payroll data) after the 1.0% upside surprise in retail sales hit on August 15. Markets have clearly shifted to a ‘good news is good’ phase and a stronger-than-expected retail sales report would move the recession narrative further down the list of market concerns. A better print tomorrow should also result in equity upside but to a lesser degree than what we saw last month. The good news is good phase has a dark side as well with a bad retail sales number likely generating downside for equity markets. Of the last 12 monetary easing cycles, only 4 were accompanied by a soft landing and none of those soft landings were preceded by yield curve inversion. The remaining 8 easing cycles were accompanied by a recession and every one of those was preceded by curve inversion. Historically, equity markets have not responded well to easing cycles accompanied by a recession and near-term macro data will be key.