September 1, 2023
Yesterday, 10-year bond yields reached our near-term target of ~4.09% intraday, while the 5-year yield has dipped but remains above our target of ~4.14%. The result is a 5/10 yield curve inversion in the -10 to -15bp range, which falls short of bullish signaling for equity markets. A positive 5/10 yield spread would generate some equity upside, while a spread greater than +19bp would signal an imminent Fed pivot. A report in today’s WSJ discusses the lagged effects of monetary tightening with a warning that the fallout from higher borrowing costs has been delayed but it’s still coming. A recession that’s perceived as short or shallow doesn’t always result in equity market downside as investors ‘look across the valley’ to accommodative policy. In our opinion, a healthy bull market requires a cyclical recovery, and a cyclical recovery requires monetary policy accommodation. The earliest signal of policy accommodation should be evident in the shape of the 5/10 yield curve.
The S&P 500 (SPX) recovered this week as the passing of the Fed’s Jackson Hole event removed an overhang. This week’s data mostly supported the idea that the Fed is done with rate hikes, but it’s not a foregone conclusion by any means. The August CPI report on September 13 will be the last major inflation report going into the September 20 FOMC meeting. Expected deceleration in shelter price inflation could put downward pressure on CPI for months to come, but the Fed’s preferred inflation measure is now super core PCE, which measures services inflation ex-housing. PCE is reported late in the month and yesterday’s +4.7% YoY July super core PCE print remains well above the Fed’s +2.5% target. The elevated super core PCE rate will likely keep the Fed ‘data dependent’ in its 9/20 communique, and keep the SPX contained at levels below ~4525.