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Inside Markets — Quarter End

Quarter End

June 26, 2023

Equities are starting the week mostly lower into month-end and quarter-end rebalancing. Given the recent rally in equities and sell-off in bonds, we estimate an incremental ~$50B of equity supply will hit this week.  The rebalance usually starts a few days before the last day of the month, so this ~$50B will likely be spread over 2-3 days. The rebalance is also occurring while companies enter pre-earnings blackouts for announced buyback plans.  The CQ2 earnings season begins on Friday, July 14.

After breaking above technical resistance at ~4200, the S&P 500 (SPX) rallied another ~5% with no obvious signs of exhaustion or reversal.  The index reached technical overbought status on Friday, June 16 and was due for a period of consolidation. The SPX has pulled back -1.8% over the last six sessions.  The most obvious downside target for this consolidation phase is former resistance at ~4200.  This area also includes the rising 50-day moving average for the index. We would dust off our tactically bearish call if the index breaks below 4200.

The cyclical sector leadership from late May needs to reassert itself if the broader market has a chance of extending gains.  We see this as a low probability event given the Fed funds rate is 2x higher than the neutral rate and US money supply is in outright contraction. Cyclical sector leadership often follows acceleration manufacturing PMI data and higher bond yields that reflect expectations for better growth.  As we learned last week, manufacturing PMIs are not converging with services.  In fact, the opposite appears to be happening with flash services PMIs in the US, UK and Eurozone missing consensus estimates.  US weekly jobless claims have broken above a multi-month range and made a new 52-week high last Thursday. While the absolute level of jobless claims isn’t yet alarming, a new 52-week high indicates emerging cracks in the labor market.  A similar break in jobless claims to a new 52 week high in 2001 and 2007 generated a shift from hawkish to dovish rate expectations.

We expect lower bond yields through the second half of the year with the benchmark 10-year yield falling from 3.72% to ~3% by year-end. The 5-year Treasury yield should decline at a similar pace, eventually leading to an upward sloping 5/10 yield curve.  A positive 5/10 yield spread would signal an imminent Fed pivot.  The 5/10 yield spread is currently -25bp with strong support near -27bp. The moves we’re expecting in both bond tenors should eventually yield a positive slope. We’ll see where we are when we get closer, but a +9bp 5/10 yield spread late in the year would likely signal an imminent Fed pivot.

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