June 29, 2022
The forward curve is pricing in a decline in headline inflation and we expect lower goods prices H2’22. Energy prices will likely remain elevated and could rise further based on underinvestment and refining capacity. Core inflation (excluding food and fuel) is primarily been driven by vehicle and housing prices. Used vehicle prices are already declining as new vehicle production ramps (improved semi supply), but higher rent looks to keep core services inflation at elevated levels in H2’22. We still see a low probability of recession this year and next, but it really depends on how central banks (Fed and ECB) react to growth disappointments. At present levels, US equities (especially small caps) look cheap if a recession can be avoided. Markets won’t wait for GDP data to make the call, and will take cues from terminal Fed rate expectations instead. US equities will likely rally if terminal rate expectations fall below 3% and the S&P 500 (SPX) could push through technical resistance at ~4200 after two inflation prints miss. The 4200 level also looks like a critical buy trigger for CTAs and other systematic funds.