August 8, 2023
The recent widening in credit spreads should be closely followed in the days ahead. Recession risk has been priced out of equity markets, but rising recession risk usually starts in credit markets. The post-pandemic economic environment has been characterized as resilient, but year-to-date High Yield default rates have already surpassed full year 2022 numbers and credit conditions are tightening.
Bond yields: Ten-year Treasury yields have pulled back from October highs near 4.20% to next level support in the 4.04%-4.02% range. While the inability to break above ~4.20% meets our expectation, the pullback is part of a broader global risk-off trade that often proves ephemeral. A break below ~4.02% would kick off a mean reversion trade to ~3.91% and increase conviction for our ~3.60% year-end target.
SPX: Near-term downside in the S&P 500 also fits our tactical equity outlook, but we keep a bullish bias at closing levels north of 4325, which is ~3.5% below current prices. An announced end of the Fed’s hiking cycle would lead to bullish yield curve steepening, which is generally favorable for equities. We look for the soft patch to continue until the Fed makes this announcement at the Jackson Hole event August 24-26 or at the September 20 FOMC meeting.