CPI, The Fed and Volatility
September 12, 2023
VIX: Implied equity volatility has been a nonfactor for markets since late March, which is why we’ve added it to the ‘Markets’ section above. High levels of volatility provide a strong headwind for equity markets, while low levels cushion potential downside. The CBOE Volatility Index (VIX) measures volatility as the midpoint in S&P 500 (SPX) index option quotes. VIX levels below 20 are generally considered low or benign, while levels above 20 become a problem for equity rallies. Extended periods of low volatility tend to end suddenly and severely. Plate tectonics and the pressure that builds over time may be a suitable analogy. Once released, high levels of volatility often take months to normalize as participants swing from one extreme to another. A six month period of benign equity volatility in April-September 2018 was interrupted by hawkish comments in early October from a newly appointed Fed Chair Powell. His promise to raise rates ‘above neutral’ drove a sudden spike in bond volatility that reached the equity market less than 24 hours later.
SPX: We continue to see 4525 as the near-term ceiling amid ongoing monetary policy uncertainty. Nearly everyone expects the Fed to skip rate hikes at the September 20 meeting and maintain its data dependent approach. This type of outcome would make the updated dot plot in the Summary of Economic Projections the remaining wildcard. An updated dot plot that signaled no more rate hikes for the balance of the year could push the SPX through technical resistance at ~4525. A lower 2023 median dot requires a change of heart from three Fed members. And a change of heart requires tomorrow’s CPI print to undershoot consensus by a fairly wide margin.
Data dependent: Consensus expectations for headline CPI have ticked higher overnight to +0.6% from +0.5%. An inline or higher print will likely result in 10-year yields trading above the ~4.34% cycle high established on August 21. And a new cycle high in 10-year yields would generate downside for the SPX. A headline CPI print of +0.45%-0.55% would result in lower yields as bond prices stage a long-awaited bullish trend reversal. Lower bond yields should produce near-term upside for the SPX capped at levels near 4525. And a headline CPI between +0.3%-0.45% has the potential to change the dot plot math at next week’s FOMC meeting, resulting in a SPX upside beyond 4525.