Morning Notes — Fed Scenarios

Fed scenarios going into Wednesday’s Fed meeting lean equity friendly. Rate hike expectations range from 50bp to 100bp with 75bp the most likely outcome. A 75bp hike with a dovish press conference likely results in S&P 500 upside of 2-3%, while a 75bp hike and hawkish press conference (most likely outcome) takes the SPX down 1% with strength into the close for a +0.5% gain. The most bullish scenario of a 50bp hike and dovish press conference seems unlikely, but could result in 10-12% upside. The most bearish scenario would be a 100bp rate hike and hawkish press conference to generate 6-8% downside.  A 50bp hike with hawkish takeaways could take the SPX up 4-5%, while a 100bp rate hike with dovish takeaways is probably worth 4-5% in terms of SPX downside.  

Inflation: Wednesday’s Fed meeting will impact markets, but Friday’s October Jobs Report has the potential to be a more important catalyst for equity markets.  Inflation pressures usually start in commodity prices, then move to goods prices, services prices and finally wages. We’ve already seen commodity prices meaningfully decelerate since the summer peak with goods prices starting to rollover. Companies issuing negative forward guidance this quarter have cited weaker demand and increasing inventories, which will put downward pressure on goods pricing. We expect lower services inflation beginning with the November data.  There are also emerging signs of a weakening labor market as survey data shows we’re past the peak in terms of corporate intentions to increase wages. A period of disinflation has already begun with headline and core CPI set to inflect lower in the months ahead and into next fall.

SPX: Near-term technical resistance for the S&P 500 (SPX) remains at the 3900 level with terminal rate expectations as the most significant directional driver. The likelihood of breaking above 3900 increases as terminal rate expectations fall toward 4.75%.  Terminal rate expectations up +4.5bp today to 4.92%.  We’re now in a catalyst-rich environment with Wednesday’s Fed meeting, Friday’s Jobs Report and next Thursday’s CPI print possessing the necessary density to drive terminal rates in the near-term.  Popular CTA buy signals sit in the 3910-3940 range, so higher levels likely leads to increased momentum with significant technical resistance in the 4100-4200 range.  Sustained closing levels above 4200 probably requires terminal rates falling below 4.5%, while levels above 5% likely takes the SPX back to the 3500 handles.

Tech: Ten-year real yields look like they’re peaking around +150bp, which means the bulk of expected multiple contraction in Tech has already occurred.  When they come, lower nominal yields will allow all equity multiples to expand, but Tech leadership requires lower real yields. We see the potential for Tech to outperform once 10-year real yields fall below +84bp.