The ugly stick was out and about on Wednesday. The stick was not shy in who or what it touched, and everything it touched was worse off for it. Equity index futures had been trading higher early. You could almost feel that a very negative trap had been set... for the marketplace. Fed officials had been so hawkish in their rhetoric going into and out of Jackson Hole. Did they know something that the rest of us could not? It sure seemed that way.
Consumer level inflation for August, at least as it is currently measured by the Bureau of Labor Statistics, hit the tape on Tuesday morning. It was hotter than expected. It was hot in all the wrong places. It sent investors running scared. Headline August CPI printed at +0.1% month over month and +8.3% year over year. The year over year print was down from July's 8.5%, but both of these numbers were above consensus. Yes, even with the benefit of gasoline prices that dropped 10.6% month over month and fuel oil prices that decreased 5.9% month over month. These prices were somewhat offset by a 3.5% m/m increase in prices for piped gas service. This did not portend well for the core rate.
At the core, (ex-food & energy) August CPI hit the tape at +0.6% m/m, up from 0.3% in July, and +6.3% year over year, which was up from July's 5.9%. This was the highest year over year print since the month this series last apexed (March 2022). Almost a new peak. Nobody wanted to see that. August was also the second straight month that prices for both Shelter and Medical Care Services grew above trend after these two categories had lagged for several months. The fact that consumer level inflation might still be broadening to parts of the economy that had not been hit quite as hard is not just troubling, it's terrifying.
Financial markets had obviously priced in a much cooler report than was released. The S&P 500 gave up 4.32%. The worst day for the US market's broadest large cap index since much of the country was in lockdown back in June of 2020. The Nasdaq Composite surrendered a very ugly 5.16%, as the Philadelphia Semiconductor Index took a beating of 6.18%. Smaller cap stocks "outperformed" with the S&P MidCap 400 down "just" 3.7% and the Russell 2000 off by 3.91%.
They have streets after the results of Tuesday's regular session price discovery... "One Way." Losers beat winners at the NYSE by almost 7 to 1, and at the Nasdaq Market Site by a rough 4 to 1. Advancing volume took a 21.5% share of composite Nasdaq-listed trade and just a 5% share of that metric for NYSE-listings. A hard lesson was learned by those who choose not to wait for any volume-based confirmation of a change in trend prior to allocating capital. For four consecutive "up" days, we sounded the alarm on volume. I heard that warning from no one else.
The pros finally showed up on Tuesday, and they weren't bullish. Aggregate trading volume increased 10.8% day over day for NYSE-listed names, and a whopping 21.5% day over day for Nasdaq names. Trading volume across the S&P 500 and Nasdaq Composite easily topped in each case, their trading volume 50 day simple moving averages. Professional money was on the move on Tuesday, trying to turn holdings into cash, but they were too late to get their price in many cases. Everyone can not use a single door to exit all at once.
The action in Treasury markets was paramount. The yield for US Two Year Note tacked on 18 basis points on Tuesday, reaching 3.75%, its highest level since October of 2007. I see that particular yield trading at 3.78% this morning after peaking above 3.8%. The yield spread between the US Ten Year Note and US Two Year Note broke through a key trendline that had been rising on Tuesday...
... The more deeply inverted posture of this spread is reflective of now greatly increased doubt that the US economy can achieve anything close to a "soft landing." Let me explain.
The US central bank, already convinced that aggression is the better path, will feel forced at this point to act more boldly going forward. The Fed will feel that they almost have to damage the US economy in order to get their dual mandate back in balance. In addition to the Fed's quantitative tightening program which is really only getting started, the FOMC will have to take the Fed Funds Rate above the theoretical "neutral" rate, and probably do so at next week's meeting.
The deal is this. Many of you know. Some of you might not. We often track the Atlanta Fed's GDPNow model for real-time modeling of economic growth. The Cleveland Fed publishes a Nowcasting model for real-time inflation, and this model is revised daily. Currently the Cleveland Fed's model shows September CPI running at 0.33% m/m and Core September CPI at 0.51% m/m. This would be up-ish from the BLS August prints (from yesterday) of 0.1% and 0.6%, respectively. As for the year over year basis, Cleveland shows September CPI running at headline growth of 8.21% and core growth of 6.64%. This would be again be up-ish from the BLS prints for August of 8.3% and 6.3%, respectively. What Cleveland is telling us is that as of now, headline inflation is stabilizing where it is, and core inflation is actually still heating up. That's problematic.
This morning, I see futures trading in Chicago that are pricing in a 66% probability for a 75 basis point rate hike next week, and a now 34% likelihood for a full percentage point increase. This would take the Fed Funds Rate from today's range of 2.25% to 2.5% up to 3% to 3.25%. Futures are then pricing in a 73% probability for at least another 75 basis points on November 2nd. This would place the FFR at 3.75% to 4%. Futures pricing now lays expectations that the FFR ends the year at 4% to 4.25% and peak for the cycle in February 2023 at 4.25% to 4.5%.
Remember, it generally takes Main Street, USA (with the exception of housing) at least nine months to feel changes in monetary policy. The people have not yet felt most of what the Fed has already done, nor has it really started to impact economic activity. According to the St. Louis Fed, the velocity of M2 money supply actually increased for the second quarter.
We already know that credit card usage has been ramping notably higher. On Tuesday, we learned that according to the FDIC, deposits at US banks decreased by $370B during the second quarter as well. This was the first quarterly contraction in US savings since 2018, and the largest quarterly contraction in savings in the history of the United States. Yes, velocity increased during the second quarter. The good people of Gotham and elsewhere raided their savings and borrowed in order to maintain the standard of living that their households had become accustomed to. This is before they lost their jobs, which is still to come. That's when velocity starts to drag once again. That's when it gets tough. Really tough.
The Markets and You
My opinion is that traders need to remain "cashy" going into the wee hours and into weekends. Investors who need to participate should reposture weighting to where exposure is greatest to areas that benefit from anything close to inelastic demand. That's what the Fed is trying to do... destroy demand through a "reverse wealth effect"... This means that equities have to trade at reduced multiples and that other even hard assets, such as real estate and precious metals could lose perceived value, though perhaps not in relative terms as rates rise and the US dollar strengthens.
Areas that I see as inelastic would be Utilities, Health Care, National Security and Cyber Security. There are more, but those are my focus areas. Cyber Security is still expensive so that area is tricky. I bought the dip on Tuesday, initiating new longs in two old friends... Northrop Grumman (NOC) and Palo Alto Networks (PANW) . I intend to grow both positions, but honestly who knows. Once I am in a fistfight, everything changes.
How To Proceed
Everything is for a reason. Slow down if you have to.
All avenues of approach, perceived threats, and targets of opportunity.
To changing environments. Become what is required when it is required.
Find a way. Even in the face of persistent failure. Learn constantly.
With the mission. No beginning. No end. Ongoing.
Yes, you can. Screwed up? Screwed up a few times? So be it. Correct course. Fight on. See that little kid in the picture on your desk? That kid thinks that you're a hero. Be that hero. Be a shining beacon, even if you never have been before, of all that is pure and good. Be who that kid thinks you are. Dedicate yourself to the task at hand. I know that if you're up way before the rising sun and reading this, that you are a force to be reckoned with. Now, wind it up. Be yourself. Be mighty. Always.
Fear is but for the wicked. So, let the wicked tremble before us.
Economics (All Times Eastern)
07:00 - MBA 30 Year Mortgage Rate (Weekly): Last 5.94%.
07:00 - MBA Mortgage Applications (Weekly): Last -0.8% w/w.
08:30 - PPI (Aug): Expecting 8.9% y/y, Last 9.8% y/y.
08:30 - Core PPI (Aug): Expecting 7.1% y/y, Last 7.0% y/y.
10:30 - Oil Inventories (Weekly): Last +8.844M.
10:30 - Gasoline Stocks (Weekly): Last +333K.
The Fed (All Times Eastern)
Fed Blackout Period.
Earnings Highlights (Consensus EPS Expectations)
Before The Open: (DOOO) (2.63)