Damned If They Do, Damned If They Don't | Morning Express 10/04/2022

Posted: Oct. 4, 2022, 8:41 a.m.

E-mini S&P (December) / NQ (December)

S&P, yesterday’s close: Settled at 3690.25, up 88.75

NQ, yesterday’s close: Settled at 11,285.75, up 250.25

Fundamentals: “The Federal Reserve will tighten until something breaks, don’t fight ‘em.” I am sure you have heard this over and over for months. It has broadly worked, but there have certainly been opportunities on the other side. In fact, significant risk-on rallies have taken hold amid the most hawkish and negative conditions. After a capitulation of sentiment, if you will. Have we again reached such a turning point? The S&P set a fresh yearly low on Friday’s quarterly close and extended the selling through Sunday night, before turning sharply during U.S. hours Monday. How did we get here? Fed Chair Powell’s Jackson Hole mic drop, a hot August CPI, the FOMC’s rising yearend rate target, a dogpile of hawkish rhetoric, and September inflation expectations remaining stubbornly high. As these narratives took hold, it also created chaos and dysfunction in currency and rate land, something we covered extensively over the last two weeks. However, there are many similarities to the summer turn. Excessive pessimism closed out the June quarter two weeks after a hot May CPI and mounting hawkishness from the FOMC, but July’s risk-on rally took hold when the path of those expectations could not extrapolate anymore. Last Monday, the CME’s FedWatch Tool had the odds for a 75bps hike in November at 75%, before eroding to near a 50-50 with a hike of 50bps before the weekend. The odds of a 75bps hike are now at 60% this morning. Last week, the U.S. 10-year yield’s test of 4% and a sharp rise of global yields certainly created added stress. The 2s10s spread, a recession indicator, has shown little reprieve, barely lifting from the historic -0.50bps floor. By some arguments, a more prominent recession indicator is the 3-month and 10-year spread. It has yet to go negative but fell out sharply since last Monday’s peak of +0.65bps to +0.21bps today. As the Fed’s 300bps of rate hikes is digested by the economy, 225bps over the last three meetings, the stresses can be found. Commodity prices, according to the Bloomberg Commodity Index have slipped by about 10% from their August peak and back to the July lows. Home Prices, according to data from Case Shiller through July, have leveled off and there is reason to believe further deterioration is ahead for August. Whereas indicators like those are signaling the stresses, that things are on the verge of breaking, others such as labor remain tight and Owner’s Equivalent Rent sticky (OER makes up one third of CPI). Yesterday, ISM Manufacturing avoided contraction, but hit the lowest level since May 2020, when coming out of the pandemic. Manufacturing Prices also hit the lowest since May 2020 and the Employment component contracted for the fourth time in five months. Furthermore, conditions aboard due to the currency and rate chaos have deteriorated much more. Will the Federal Reserve bend or break something; ignoring signals, only focusing on labor which is a more structural issue and drastically lagging OER? Yesterday, NY Fed President Williams said, “Tighter Monetary Policy has begun to cool demand and reduce inflationary pressures, but our job is not yet done.” The FOMC certainly fears lifting their foot off the gas and allowing pressures to reinvigorate, but things are clearly on the verge of breaking; they are damned if they do, and damned if they don’t.

Do not miss our daily Midday Market Minute, from yesterday.

JOLTs Job Openings and Factory Orders are both due at 9:00 am CT. Traders also want to keep an ear to the ground for Fed speak.

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