July 12, 2022
Better-than-feared early Q2 results amid defensive positioning and extreme bearish sentiment could result in a squeeze higher. We continue to see the 4150-4200 level as strong technical resistance, with a break above requiring a terminal Fed rate target below 3% (now 3.45%). Equity market volatility also remains a headwind with the CBOE Volatility Index (VIX) still above our rule of thumb trigger of 20 (now 26.15). Fed tightening expectations were the cause of the January correction, but sharply higher 10-year inflation expectations following the 2/24 invasion was the cause of the spike in volatility. Ten-year inflation expectations are derived from TIPS pricing with post-invasion retail flows overwhelming a relatively illiquid market. The Fed followed with extremely hawkish rhetoric, but individual investors continued crowding into a dangerously overbought TIPS market leading to irrational cross market collinearity. The overcrowding in TIPS has unwound with 10-year inflation expectations now back to levels seen 2 weeks before the invasion. Unfortunately, it usually takes several months for volatility to return to neutral levels once it spikes…we’re getting closer.