Near Term SPX
May 26, 2022
At least part of the plan has come together. The challenge facing markets from late February-early May was a breakdown in normal collinearity between inflation breakeven yields, Fed rate expectations and longer-dated nominal bond yields. The breakdown started with investors crowded into a thin TIPS market in the wake of the 2/24 invasion. Crowding pushed breakeven yields well beyond cycle highs. The Fed attempted to beat back the spike in breakeven yields with cascading hawkish rhetoric. This caused a mini-panic in the bond market with heavy selling of longer-dated bonds (yields up) and sharply higher volatility (MOVE Index), which quickly made its way to higher stock market volatility (VIX Index). About 6 weeks ago, we noted that 10-year breakeven yields seemed to be topping out and accurately identified 280bps as key support. We also said a break below 280bps would likely break the spell that markets had been under for the last two months. Ten-year breakeven yields traded through 280bps to close at ~274bps the same day and rational collinearity in these cross markets were restored, allowing bond yield volatility and stock market volatility to come off peaks.
The bigger plan is for equity volatility (VIX), now at 27 to descend closer 20, removing a major headwind for a sustained equity recovery. Getting the VIX closer to 20 requires inflation breakeven yields to remain anchored in the 263-268 range and for terminal Fed funds rate to continue approaching 2.50% (now ~2.70%). The next technical hurdle for the S&P 500 lies just ahead in the 4,100-4,150 range. Sustained levels above 4,150 would further support a bullish narrative. We’ll use a Mr. T quote regardless of where April PCE prints tomorrow.