The WOTE Public: Time to Chill
Rangebound price action likely until Powell on 8/25 before downside opens up into the September/October seasonal danger zone.
Discussion
Today’s cross-asset price action1 perfectly encapsulates the SPX outlook into FED Chair Jerome Powell’s Jackson Hole speech on August 25: higher rates at the long-end of the UST curve limit upside, while Treasury Secretary Janet Yellen’s TGA QE program limits downside. Let’s start with rates.
In the immediate aftermath of the 8:30am EST CPI report, the 10-2 UST curve bull steepened, led by 2s, on optimism that inflation is coming down and the Fed is done hiking. By 9am the entire move had been erased via 2s recovering their losses (10-2 curve in the top panel below, 2s in the bottom), and then the curve went on to steepen over the course of the day in two phases: first a combination bull/bear steepener (2s falling, 10s rising), then ending with an outright bear steepener with rates rising across the curve.
The fact this move in rates occurred in the wake of the Fed signaling an end to rate hikes is a critically important signal: It means that until the labor market cracks, rates are very likely headed higher. And given how fully valued the equity market is, durable upside for stocks from here is very limited (if there even is any). But downside is limited, too, which brings us to Yellen.
As I flagged in the footnotes of an August 2 Market Journal post, the Strategas policy team alerted me to the possibility that Yellen might spend down the TGA this month in an effort to “save the stock market”. Interestingly, this was confirmed by The Kitty today on Xwitter (to the extent you can get “confirmation” from a Xwitter anon).
This TGA QE program goes a long way toward explaining the controlled nature of the equity market correction this month generally, and today specifically. If you had told me last night that the curve would bear steepen in response to an in-line CPI print and the Fed signaling an end to rate hikes, I would have guessed SPX would have corrected at least -3%. Yes, it corrected, but it was so controlled - far less volatile than the move in bonds. Until we get through OPEX next week (8/16-8/18) and Powell on 8/25, this very controlled market behavior is likely to continue. However…
Once we get into the seasonal danger zone of September/October, an economic force larger than the TGA is likely to enter the game: either rates move substantially higher on an economic reacceleration, or the lagged effects of rate hikes begin to hit the labor market.
But until 8/25, it’s time to chill.
(And yes, I reserve the right to change my mind on this view at a moment’s notice any time between now and 8/25.)
Thx for continuing to share your thoughts. Yield curve movement has been super interesting. And while everyone likes to say higher for longer, no one seems to have conviction on how much higher or how much longer.