August 3, 2022
Fed: The past two days of hawkish Fed rhetoric has pushed terminal Fed expectations from ~3.25% to ~3.45%. We’ve been following a tight negative correlation between equity performance and terminal Fed expectations since early-May when it was apparent that 10-year inflation breakeven yields had rolled over. The May 9 new cycle low in 10-year breakeven yields triggered the shift in focus from inflation to a policy-driven recession. We expect the focus will shift from recession to recovery once terminal Fed expectations can sustain levels below 3%.
SPX: The S&P 500 is currently testing technical resistance in the 4150-4200 range. The SPX got to this level based on the Fed sounding more flexible with its policy approach after acknowledging that growth had rolled over at its July meeting. Fed funds are now at the neutral rate of 2.50%, but terminal (December ’22) rate expectations sit at ~3.45%. We don’t expect the SPX will be able to sustain levels north of ~4200 until terminal Fed expectations move closer to the neutral rate (below 3%). The catalyst for a lower terminal rate is lower realized inflation. It may not be enough for inflation to decelerate inline with expectations in the short-term. Any near-term shift in terminal rate expectations will likely require realized inflation data (CPI or PCE) to miss consensus expectations by a decent margin…like the prices paid component in today’s ISM survey. For now, we expect more consolidation at levels below 4180.