December 1, 2022
Near-term SPX: The CBOE Volatility Index (VIX) has returned to ‘normal’ levels near 20, which temporarily removes an equity headwind that’s been present for most of the year. This marginally improves the chances for the S&P 500 (SPX) to break above resistance in the 4100-4200 range if/when terminal rate expectations fall below ~4.75%. Terminal rate expectations in OIS forwards have declined from a recent peak of ~5.06% to ~4.88% today. Tomorrow’s Jobs Report has the required density to shift macro fundamentals and drive terminal rates lower or higher. Consensus for non-farm payroll gains is currently +200,000. A number near/below +100,000 could drive terminal rates closer to 4.75% and push the SPX to the top end of resistance – maybe beyond. A number above +250,000 would take terminal rates back toward 5% and erase yesterday’s ~3% gain.
Fed: Economic fundamentals are just starting to show signs of a downturn. The good news is that inflation data is tracking a similar path. Yesterday felt like the day when markets shifted the focus from inflation concerns to downturn/recession concerns. Recession concerns will likely dominate market behavior through most of Q1’23. Consider that businesses and markets had been operating with essentially no cost of capital for the last 13 years. That abruptly changed this year with the cost of capital rising by ~600bp on average. Over the last 15 months, 10-year real yields have increased +270bps to +150bp, which is the fastest rate of change in more than 40 years. No one knows how this will play out, but it seems like the Fed will need to be ‘forced by markets’ into easing sometime next year in a setup similar to what occurred in 2018.