August 30, 2023
Bond prices and stock prices are positively correlated at the moment because inflation remains elevated. US equities need lower yields in order to move materially higher from here. Unfortunately, bond yields reflect market expectations of future growth, so you need softer economic growth to produce lower yields. And too much deterioration in economic growth usually raises concerns for corporate earnings. The obvious paradox reinforces our conviction that rally attempts will remain confined within technical resistance levels. One of those resistance levels for the S&P 500 (SPX) lies just ahead at ~4525.
Over the last 60 years there’s only been three occasions when the Fed has engineered a soft landing following a tightening cycle of >250bp. The probability of a soft landing in the current environment seems low given that the current tightening cycle has been the most severe in terms of magnitude. A soft landing from here probably requires a quick Fed pivot. Expectations for early recognition and swift action are low given how the Fed started the current tightening cycle. If the Fed was going to pivot, the earliest indicator would be the 5/10 yield curve flipping into positive territory and breaking trend. In the current environment, a change in trend occurs when the 5/10 spread extends beyond +19bp. The 5/10 spread sits at -14bp at the moment and we see the current steepening phase topping out at ~5bp. Moving beyond -5bp likely requires a surprise decline in tomorrow’s ‘super core’ PCE and/or major miss in Friday’s non-farm payroll number.
Volume and attendance remain light this week despite a number of important catalysts still to come including: 1) CRM earnings this afternoon; 2) China NBS PMIs tonight; 3) Eurozone CPI for August and US PCE for July tomorrow morning; 4) AVGO, DELL and LULU earnings tomorrow night; 5) US Jobs Report and ISM manufacturing for August on Friday morning.