Evening Brief – 08.09.23
While considering the overall outlook for the equity market, one ought to pay extra attention to what’s happening in the bond market. Rising bond yields indicate a significant threat to the company valuations and future earnings. And, while there is plenty of discussion about whether the Fed is justified in hiking the Fed funds rate to 6.0%, the FedWatchTool reveals that only 13% expect another quarter-point increase at the September FOMC meeting and 30% at the November confab.
The probability of a further increase in rates was lowered by last week’s jobs data, which showed that July nonfarm payrolls were slightly lower than expected, while the unemployment rate fell to 3.5% from 3.6%.
The shifting recession narrative can be seen in fixed income volatility, through the MOVE index, and equity volatility, through the VIX index. The MOVE index has jumped over 10% since the end of July; a large move by historical standards. The 10-year yield has surged 60 basis points over the past 2 ½ months from 3.6% at the end of May to over 4-20% last week.
Meanwhile, the VIX has exploded higher by nearly 30% since July 26, which has unsurprisingly led to a decline in the equity markets.
Despite the volatility, investor mood remains moderately encouraging. But this improved optimism will be put to the test on Thursday when the July US CPI data is released. The market consensus is for a rise of 0.2% in both headline and core. The CPI, year over year, is forecast to rise 3.3% in July after rising 3% in June. Core CPI, year over year, is forecast to rise 4.8% in July for the second month in a row.
It comes as a closely monitored bond-market index of inflation expectations rises back toward a nine-year high, signifying prolonged price pressures. The US five-year inflation breakeven rate, which is largely a proxy for crude oil prices, has risen to around 2.5%, just shy of the peak in April 2022, when it reached the highest since 2014.
To service the large US debt that Fitch and other rating agencies perceive as a long-term threat to the economy, inflation must fall further. Even if the Fed doesn’t raise interest rates further, the debt will continue to soar as existing debt is replaced with new debt serviced at higher prevailing rates.