Inverted Yield Curve
September 5, 2023
September always brings a lot of discussion about seasonality given that it’s the worst performing month of the year. But while September’s average return is negative, its median return is ~0%. And when the S&P 500 (SPX) is up double digits coming into September – like it is this year – then September tends to be positive too. Note that we may see an increase in equity supply this month with high-profile IPOs from Arm and Instacart likely, while Saudi Aramco said on Friday it may sell an additional ~$50B worth of stock.
The bullish narrative we laid out at the beginning of August was largely based on the Fed signaling an end to its tightening cycle at either Jackson Hole or the September 20 FOMC meeting. It’s been said that Fed officials need to see at least three consecutive declining inflation prints (CPI and/or PCE) before they get comfortable that we’re in a sustainably declining inflation environment. We haven’t seen three consecutive declining prints and unlikely to get there until at least Q1’24. Consensus for next week’s CPI report is looking for headline CPI of +0.5 vs. the July print of +0.2%. If that’s accurate, the YoY rate would rise to +3.5%. Consensus is looking for core CPI of +0.3% vs. +0.2% for a YoY rate of +4.4%. The bond market is pricing in a ~37% chance of another rate hike this year, and the realization of these CPI numbers will probably take the probability closer to 50%. We doubt this develops into heightened bond market volatility, but the increased likelihood of more rate hikes would likely provide a headwind for equity markets.
We continue to view 4525 as near-term resistance for the S&P 500 (SPX). We expect that level will hold amid an uncertain monetary policy path. Upside through 4525 could follow a steepening in the 5/10 yield curve, but we don’t see that happening this quarter. In our opinion, steepening in the 5/10 curve beyond -5bp would be a bullish development for stocks, while sustained levels through +19bp would signal an imminent Fed pivot. A healthy bull market requires a cyclical recovery, and you generally don’t get a cyclical recovery without monetary policy accommodation and expanding money supply. Given the above CPI forecast, we think its increasingly likely for the yield curve to remain inverted and below -5bp until Q1’24.