August 31, 2022
Rate hikes: The pace of rate hikes hasn’t really changed with markets still pricing in nearly the same probability for a 75bp September hike post-Jackson Hole. The terminal rate is also little changed, up from ~3.62% to 3.73% post-JH. The Fed is expected to hike 50bp or 75bp in September, 25bp in November and a final/terminal 25bp hike in December. That takes Fed funds to the 3.50-3.75% level by year-end. The biggest change from the Fed at Jackson Hole was a greater shared concern for inflation rather than growth. That message pushed out the probability of the first rate cut in ’23 from September to November. It also took 1-year inflation breakeven yields from 2.96% to ~2.21% today, which is below the Fed’s stated inflation target of ~2.50%
Bond yields: Ten-year Treasury yields have backed up from 2.57% (prices at extreme overbought) to 3.12% today on a mean reversion trade. We see ~3.15% as the top of the near-term range and see a pullback in the US dollar (looks a bit stretched) attracting buyers of Treasuries (yields lower). First level support (resistance for prices) sits at 2.98% and a break below gets you to the ~2.88% level.
Tech: Ten-year inflation breakeven yields have started moving lower from the recent peak of 263bp to 253bp today. Our near-term forecast is for a steady pullback to ~230bp. This is important for the relative performance of Tech given the sector’s strong negative correlation with 10-year real yields. Lower real yields support higher multiples and the massive outperformance in Tech from March ’20-September ’21 was the result of deeply negative 10-year real yields. Our decision to rotate out of Tech and into Value sectors in the fall of ’21 was based on 10-year real yields making a series of higher lows in late August before breaking out in late September. Our near-term forecast doesn’t necessarily bode well for relative Tech performance given a 288bp nominal yield and 230bp breakeven yield. Real yields are calculated by subtracting inflation expectations (breakeven yields) from nominal yields, so our forecast is for 10-year real yields of +58bp. We expect relative Tech outperformance once 10-year real yields break below pattern support at +12bp.
SPX: The S&P 500 (SPX) broke technical support at 4070-4080 last Friday, which has us focused on a 3900-3945 level. Higher rate volatility (MOVE Index) post-Jackson Hole dragged equity volatility higher as well, with the CBOE volatility index (VIX) now presenting a gentle headwind at 25.70. A sub-21 VIX and oversold conditions in the 3900-3945 range could result in another attempt at ~4300 where the 200-day moving average and 52-week VWAP reside.