February 6, 2023
Last week, the S&P 500 (SPX) extended through near-term technical resistance at 4100 as the OIS market began pricing in two 25bp rate cuts for the back half of this year. Friday’s stronger than expected Jobs Report has resulted in the forward curve pricing out the additional 25bp cut. The stronger Jobs Reports also results in higher bond yields and US dollar strength, which is putting downward pressure on the index as it holds just above 4100 this morning. The SPX is getting a stronger start to the year than we expected but our medium-term outlook for a retest near 3550 is unchanged. Over the last 12 months, the single most influential cross market for equities has been terminal Fed expectations. Lower terminal rates beginning in mid-October is what fueled the Q4 rally. The OIS market reached its most dovish level after the November CPI print in mid-December and stability thereafter resulted in the SPX fading from technical resistance in the 4100-4200 range. At the time, we also suggested that range would likely cap the index through H1’23.
January: The initial January rally was led by cyclical sectors as China reopening headlines drove a soft landing narrative. Sustained cyclical sector leadership is considered a bullish internal indicator. Unfortunately, cyclical sector leadership wasn’t sustained with leadership in the last two weeks coming from long-duration sectors like Communication Services and Real Estate as rate cut expectations two years forward began to price in a neutral Fed funds rate near 2.5%. Last week’s Jobs Report makes that highly unlikely as tightening cycles over the last 50 years have all followed weak labor market conditions, specifically higher jobless claims. Getting the Fed to neutral likely requires more economic pain, which will ultimately weigh on forward earnings estimates and cap the SPX in the 4100-4200 range.