Morning Notes — SOX and Breakeven Yields

Powell: Caution ahead of Powell’s address tomorrow was cited for Monday’s weakness in equity markets. Given the recent pullback in inflation data, any hawkish leaning commentary would likely be directed at the labor market, which remains exceptionally tight. At a minimum, he could use tight labor markets to push back on the idea of a dovish pivot that’s now priced into OIS forward markets in the March-July window. Wages account for the majority of the core inflation trend and labor market data is the key to bond yields and equity valuations. This makes next Friday’s Jobs Report (9/2) the most important input going into the 9/21 Fed meeting.

SPX: Extreme oversold conditions and momentum divergences in mid-June gave us confidence in a reflex rally. These oversold rallies usually last 4-6 weeks with return in the 10-15% range.  After the first week, it was apparent the buying was mostly coming from the covering of short positions.  The rally picked up speed after a sharp decline in the prices paid/received component of the NY Fed survey. Other regional surveys showed slower/lower inflation readings. We expected former support at ~4100 to serve as strong resistance, and the SPX actually decelerated at those levels until the softer than expected July CPI and PPI prints. Short-covering volume reached a 3 standard deviation event about two weeks ago and the SPX faded from ~4305 with its 200-day moving average just overhead at ~4320. While there are very few bullish fundamental triggers at the moment, we stay open minded to the potential for them to unfold in the near future and remain bullishly biased at levels above ~4080. Getting the SPX sustainably north of ~4320 probably requires a combination of cyclical equity leadership and lower inflation expectations. Today’s ~3% rally in the Philadelphia Semiconductor Index (SOX) and downtick in 10-year inflation breakeven yields is the right mix.