July 14, 2022
The current higher than ‘neutral’ terminal Fed rate is a challenge for equity markets. The Fed follows longer term inflation expectations but reacts to realized inflation (CPI/PCE). Note two-year inflation breakeven yields have declined from a peak of ~490bp in late March to ~290bp today. And commodity prices have sharply declined over the last month. This is why terminal Fed expectations have shifted from June ’23 to December ’22. Remember, equity markets discount events 6-9 months in the future when rate hikes should have ended and investors turn their attention to a recovery in ’24. It may be a little early to begin adding equity exposure, but extreme bearish sentiment and extremely light positioning will lead to violent rallies. There’s been no shortage of bearish headlines over the last two days with the SPX holding up relatively well. Technical support remains at ~3640 with a break leading to a 2 year downside pattern objective at ~3500.