July 27, 2022
Tough spot: A 75bp rate hike today would take Fed funds close to the neutral rate of ~2.50%. This puts increased attention on forward guidance and how the Fed will gauge its tightening cycle. Forward Fed guidance since March has read “ongoing increases in the target range will be appropriate.” Keeping that statement would indicate an intention of taking policy into restrictive territory as the Fed’s preferred recession indicator (spread between the 3mo T-Bill and 3-mo T-Bill 18 months from now) rapidly approaches inversion. The two-month break between today’s meeting and the next one in September could increase the likelihood the Fed moves back to ‘data dependency.’ The statement language has maintained that a pivot requires “clear and convincing” signs of inflation slowing, but that wasn’t the case in June when the Fed’s two marquee inflation reports (CPI and Jobs) came in stronger than expected. While more recent data suggests inflation may have peaked in June, the Fed’s path of least resistance today will be to leave the language unchanged.
SPX: The S&P 500 (SPX) also appears to be in a tough spot with an extremely favorable positioning set-up (cash levels high) amid downside earnings revisions, stubbornly high inflation and restrictive monetary policy. But markets discount events 6-9 months in the future. The SPX is up +5% since the highest CPI print of the year in June and Fed funds futures are beginning to price for policy accommodation by March ’23. Initially optimistic sell-side estimates for the following calendar year typically get their final cut by the end of Q2 earnings season (late-August/early-September) and these revisions often serve as a clearing event for equities to move higher.