September 25, 2023
Today’s curve steepening takes the 5/10 yield spread to -8bp with technical resistance at -7bp. A break above -7bp would be an incremental positive development for rates markets with an eventual break above +18bp signaling an imminent (weeks away) Fed pivot. We expect the 5/10 curve will have difficulty getting above -7bp and don’t expect to see something above +19bp until late Q1’24 at the earliest. And getting above +19bp will likely entail a good degree of pain for equity markets.
The S&P 500 (SPX) is trying to hold key pattern support near 4330, but we see increased CTA selling pressure with the index now trading below its 100-day moving average. CTA’s and other systematic funds often use simple moving averages as buy and sell triggers. The more cyclical segments of the US market, like the Russell 2000 (RTY) and Philadelphia Semiconductor Index (SOX), broke below near-term support last week and the EuroStoxx 50 (SX5E) broke today. The Nasdaq 100 (NDX) remains the strongest major US equity index with closing levels below 14,550 or ~1.2% below current levels constituting a break. We remain concerned that increased equity volatility could accelerate downside momentum and maintain our tactically bearish outlook.
Equity volatility as measured by the VIX index has advanced from a mid-September low of 12.8 to 17.2 today. The index was higher this morning and was threatening to break above its 200-day moving average near 17.6. A break above the 200-day moving average to a closing handle of 18 or higher would be our earliest warning signal that volatility could reach escape velocity. Once released, elevated levels of volatility (VIX >22) become a major headwind for relief rallies and often take months to subside.
There have been only three economic soft landings in modern history that followed a Fed hiking cycle >250bp: 1964-1966, 1983-1984 and 1994-1995. The one thing they had in common was strong labor markets with none of these episodes resulting in rising unemployment or increased wage pressures. The negative feedback loop from a recession usually starts as a problem with consumer credit, which leads to reduced consumption, lower corporate earnings, higher unemployment and back to reduced consumption. The negative feedback loop usually lasts until the Fed cuts rates in an effort to restart higher levels of consumer spending. Labor markets remain strong for the time being with weekly jobless claims as the high-frequency reports to watch. Rising weekly claims above 260,000 for three consecutive weeks is our sign of weakening labor markets. Weekly claims have actually been trending lower over the last three weeks with the most recent reading coming in at 201,000.