Discussion
The below was written late last night and I fell asleep before I could hit send…
At this particular point in time my read of the market is dialed in. Until that changes, I will continue to trust my signals. Like a swing thought it golf - stick with it until a new one is needed.
Yesterday, the fact defensive sectors led the rally into EOD and HY CDX didn’t move much in the rally pointed to a likely failed rally. Today’s market action confirmed that read.
Unlike yesterday, today the market dumped into EOD. But while defensive sectors outperformed on the day net-net, their outperformance gap shrunk materially from its peak in the morning to the close of trading. In addition, HY CDX barely budged on the day, VVIX fell handily from its morning peak, and breadth wasn’t terrible given the decline. By my read, the weight of this evidence points to a near-term bottoming process as underway - and given that the market is in a “window of strength”, Core CPI tomorrow is likely to come in cool enough to terminate the rate hike cycle, and Powell speaks at Jackson Hole on 8/25, the set-up is there for one last “soft landing” gasp higher into the end of August.
I’m as bearish as anyone in the market. I think the economy is far weaker than consensus believes, the unemployment rate is likely to shoot above 4.5% by 1Q24, and that September/October is going to be a bloodbath. So I don’t say this lightly at all, but I think today was an interim bottom and that SPX rips tomorrow on “event VOL” collapsing following a non-event CPI release.
In yesterday’s EOD update I said:
“If the market is defensively positioned for a hot headline CPI, I would fade that. I don’t think hot headline CPI matters until the entire TIPS BE curve starts moving up. But I don’t think hot headline CPI is why VOL is elevated right now. I think something stinks beneath the surface of this soft landing squeeze, and the fact the market is weak in a ‘window of strength’ is a major tell.”
Something certainly stinks beneath the surface, but I think CPI event VOL has more to do with the set-up into tomorrow than I gave it credit for. Gasoline prices are widely discussed, and the long end of the TIPS BE curve has moved as a result - so there is a fair amount of money betting on a hotter than expected CPI.
On one hand, the reasonable stickiness in UST 2s says CPI comes in hot; but on the other hand, the fact long rates reversed so quickly off their breakout highs tells me the disinflationary process has begun.