Morning Notes — Inflation Breakeven Yields

The S&P 500 (SPX) has already absorbed the assumed tightening in monetary policy.  Inflation expectations will need to rise in order for the Fed to do more.  Base effects make the peak inflation narrative a virtual certainty and leading indicators on PPI inflation (based metals) peaked in early March.  The debate over a future recession is a reasonable one to have, but support from US consumers (Visa’s May spending data matched April’s, up +48% from 2019 levels), global reopening and China policy stimulus make continued expansion a more likely outcome over the next 12-18 months. Fed policy doesn’t need to become accommodative for the SPX to advance from current levels. We only need to see terminal Fed expectations (June ’23 Fed funds futures) decline from 2.97% to something below 2.80%.  Terminal Fed expectations follow 10-year inflation breakeven yields, which peaked on April 21 an broke key support at 280bps on May 9.  Ten-year breakeven yields need to remain below ~283bps and trend toward ~250bps before triggering lower terminal Fed expectations.  Technical levels should be closely followed as 10-year breakeven yields made a low of ~256bps last week and are now ~275bps.  Next Friday brings US May CPI data.