In today's FS Insight First Word note we discuss how it's been a data-heavy week, but the big news was ECB yesterday and its dovish impact on bond markets.
Please click here view today's Macro Minute (Duration: 5:36).
The Federal Reserve FOMC will announce its September interest rate decision on 9/20 at 2:00pm ET. The August PPI, released yesterday, is the last key "hard data" point and futures markets have now priced in a mere 2% probability of a hike in September. And the odds of a November hike have tanked recently to 33% from 48% a few weeks ago. As we have written multiple times over the past few months, we believe these odds eventually fall to 0% and that the July hike is the last hike of the cycle. To me, this is the most important development in the next few months and also the cornerstone for why we see equities rallying into year-end.
* Yesterday, the ECB raised interest rates by +25bp, its 10th consecutive hike, to 4% and the ECB President suggested this could be the last hike. The reaction was immediate in markets as the future hikes were quickly repriced away and yields throughout the Euro area fell and triggered a large risk rally. Fed funds futures also repriced meaningfully yesterday, aided by the ECB and by the August PPI. And the odds of a September and November hike are at multi-week lows (see above).
* To me, the market reaction to ECB is a prelude to how markets will react when the Fed eventually reaches that same point. The point when the incoming data ("data dependent Fed") will convince the Fed to no longer see the need for further hikes. On that day, we expect multiple markets to reprice:
-- long-term yields likely fall
-- interest rates across the board adjust as markets start to believe "cuts" are possible
-- 30-yr mortgage rates fall by 150bp or more, as the excess spread disappears
* In all, yesterday's ECB and the market's reaction is a harbinger of the 1982 moment ahead for the S&P 500. We have written previously about this, but the key takeaway is equities went to an all-time high 17 trading days after Volcker publicly considered "ending the inflation war" (NY Times 1982).
* Yesterday's August PPI was inline and core (ex-Energy and ex-Food) is still running a very very good 2% YoY range. So, inflationary pressures for producers have been very stable at below 2%. That is bolstering our view that CPI will stay muted as well. After all, producers/corporates pay worker salaries. And with elevated wage gains, PPI is still below 2%. Think about that.
BOTTOM LINE: Our base case is September softness is "front loaded" and rally into month-end. Ending Regional Bank OW.
Since the end of July, equity markets have again become a "game of inches" and frustrating. Our base case is that September weakness is front-loaded and that the overall tone of markets should improve into month-end and the possibility of a rally of 2%-3% from Sept. 4th onwards. Equity markets are tracking to this view and even the relatively positive follow through on the "hot CPI" report this past week is a sign of that.
* We are removing our Tactical OW of Regional Banks today. The (KRE) 1.99% has been consolidating the past few weeks and we think it is prudent to become more selective. Since our OW:
- KRE 1.99% has risen 15% from 5/7 to now
-- S&P 500 (SPY) 0.93% is up 9%
-- the outperformance is >570bp and we think it is prudent to take profits
* The equity put-call ratio surged to closing high of 1.2 yesterday, the third such elevated reading in six months. And we flagged a week ago, a 1.2 or greater reading has seen equity lows within 1-2 days. This strengthens our view that equity markets likely drift higher into month end.
* UAW strike was last night, so investors likely want to see how stocks react today. But we take the view this will be a nothing burger.
* We stay Cyclical and like
-- Technology/FAANG (XLK) 0.73%
-- Industrials (XLI) 0.98%