The markets were caught badly wrong-footed by a consumer price index report showing broadly stubborn inflation, largely in services and rent. The sell-off wiped away most of the past week’s rally premised on the “falling inflation, peak Federal Reserve hawkishness” notion. The S & P 500 quickly unwinds more than half the 5% to 6% pop since early last week, which was built on oversold conditions, pessimistic sentiment and growing hope – now deferred by at least a month – that the leading indicators of inflation were looking more benign and would lead to a friendlier CPI print and therefore bring the end of Fed tightening into closer view. The result is a hash of thwarted rallies and support at higher lows, a range (3,900 to 4,200) where most of the summer was spent within a broader range and with converging trend lines. Unresolved is an understatement. At the low end of the range, an economic soft landing is assigned a low probability, at the upper end looks like a better bet. Bonds immediately and violently repriced to add in another quarter-point of Fed rate hikes before they are seen peaking above 4% early next year, with at least some slight chance of a full percentage-point boost next week rather than the odds-on likelihood of a 0.75 percentage point increase. The clear worry is the Fed will need to do a lot more to slow the economy, soften up aggregate wage levels and wage growth and tighten financial conditions to get inflation on an acceptable path. Was the market delusional to price in the chance that the Fed could soon be pausing with inflation ebbing on its own soon even as central bank speakers cautioned that they saw no pause ahead ? Not really. For one thing, high and falling inflation is one of the more bullish backdrops for stocks, historically. Many leading inputs to inflation (including used cars, energy, airfares and listed rents) have eased, as have market-based and survey-revealed inflation expectations. Markets seized upon this to take an oversold stock market higher into the CPI print. Not much more to say. Fed officials have been resolute in calling for more restrictive policy, for a prolonged time, and need several months of better data before pivoting. But they absolutely have to say this at this stage, and will be saying it right up to the moment when the market realizes they truly are done (which may or may not come as the economy buckles and or a capital-markets mishap occurs). The 3-month/10-year Treasury yield curve has compressed further as the short-term rates market prices in more hikes by the end of the year. (Interestingly, the market still sees the Fed getting to terminal rate levels in April or so – a higher plateau but reached within six months or so). The inversion of the 3-month/10-year curve is the Fed’s preferred pre-recession indicator. It has not yet inverted. In the prior three cycles this inversion happened between six and 18 months ahead of the onset of recession. Tech/growth is taking the brunt of it, as usual: higher valuations, more susceptibility to risk-off pressures, and cash flows less tied to the high nominal GDP levels that elevated inflation generates. Mega Tech remains “the stock market, only an amplified version.” META is an interesting exception in terms of valuation (optically quite cheap) and has very poor investor sponsorship. Tight multi-month range near the lows, now testing the low end. Market breadth is pretty nasty: 90% downside NYSE volume. It somewhat negates the strong breadth-thrust signals off the recent floor near 3,900 of the S & P 500, but again this remains a range trade working with a higher low versus mid-June. VIX rose quite a bit in yesterday’s equity rally ahead of the CPI catalyst, so today is up less than two points, under 26. There’s a general elevated level of concern. The indexes are back at a familiar spot, and no real panic or hedging urgency.
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