As we approach the key June Fed FOMC meeting, the market may be nudging towards new all-time highs, but the themes and stock selection choices are not as easy to read. In summary, the market is dazed and confused with no clear theme emanating and most stocks moving up or down based on consensual positions being unwound or chased.
The long-awaited May U.S. CPI exceeded forecasts, with the core price index rising 5% YoY vs. 4.7% estimate, and 0.6% MoM vs. 0.5% expected. The Core CPI rose 3.8%, the most since 1992. There is no denying that these figures were the most shocking in decades. The only caveat is that one could make a case for used car prices normalizing at some point in the future as the semi shortages ease. But then one can also make the case of higher rent inflation in the future to offset this.
Either way, the market is willing to look past this figure and go with the Fed's theory for now. As soon as we saw the print, U.S. bond yields immediately squeezed higher but then proceeded to fall back down to 1.43%. The U.S. 10-year yield has moved down from 1.65% to 1.43% at a time when every inflation metric is clearly skyrocketing higher, and shows no sign of easing as yet.
The bond market has been rallying over the past few weeks as we get closer towards the Fed meeting. This is despite commentary from many members talking about it being time to "think about thinking about tapering". There is a record short position in U.S. Treasuries so perhaps there is a bit of short covering going on. This combined with the Fed still buying $120 billion/month of assets is adding to the squeeze. Could the bond market be signaling deflation or lower for longer rates? If that is the case, then the cyclical reflation bias in the market will need to be reassessed entirely and current bias of most analysts is all wrong.
Since the start of this year, investors have been chasing the reflation/recovery trade, chasing cyclicals geared to the economic cycle like oils, industrials, banks, etc., that benefit as yields move higher. But now, even though yields have fallen, both Growth (technology) stocks as well as Value (cyclicals) are all heading higher. As the S&P 500 makes new highs, S&P 500 transports index, usually synonymous with the health of the economy, is clearly not able to make headway.
The signals in the markets across most assets seem entirely disconnected for now, be it equities, rates, commodities or bonds. Who is right? Only time shall tell. But one thing is clear, the quadruple witching next Friday does tend to distort the "real" picture as futures hedging masks the true direction of the market.
It seems the Fed is in a bit of a pickle. They can either keep increasing their balance sheet which is now closer to $8 trillion, inflating assets further risking hyperinflation, or make a decision now and start tapering a bit especially as the U.S. has now opened and the market has improved tremendously. The latter could cause a wobble in the markets near term as it needs to survive without constant QE, but may be the right choice in the longer term. Is the Fed ready to help markets start its rehab program or will it continue to feed the junkie?
