February 9, 2023
Catalysts ahead include Michigan inflation expectations and two Fed speakers tomorrow, but markets remain focused on Tuesday’s CPI report. US weekly jobless claims are slightly higher than expected, but well below levels that signal weakness in labor markets. Terminal rate expectations hold onto repriced levels following last Friday’s strong Jobs Report.
We became tactically bearish for a retest near 3550 when the repricing of terminal rate expectations slowed in mid-December and the SPX approached technical resistance in the 4100-4200 range. Terminal rates reached levels near 4.90% in mid-December and remained relatively stable as the OIS forward curve priced in 200bp of rate cuts, two years into the future. Of course, the most logical motivation for the Fed to cut interest rates by 200bp is a period of economic pain when credit spreads widen, jobs become scarce and earnings estimates rapidly decline. Friday’s big payroll gain has resulted in a bearish repricing of terminal rates, while the two-year forward curve remains priced for nearly 200bp of rate cuts.
Fed meetings and CPI reports generated the greatest amount of volatility last year. This week’s surprise uptick in the Manheim used car price index may have markets better prepared, but Tuesday’s CPI print remains the number one near-term catalyst. High levels of realized volatility last year were a strong headwind for equity markets.
Benign equity market volatility since mid-January has provided a strong tailwind for the recent rally in ‘long duration’ stocks with above average beta. Generally speaking, these are the lower quality, unprofitable stocks that underperformed last year. Higher beta sectors like Tech and Consumer Discretionary make up ~45% of the S&P 500’s weight and accounted for 85% of the year-to-date rally. An increase in volatility would quickly flip the script in favor of more defensive groups like Health Care.