Why bulls cheer the coming hit

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S&P 500 gave up not too far above the 3,965 level it could have kept as PPI decelerated not fast enough to meet market expectations. Rising yields mean markets are betting on more hawkish Fed action, even if necessarily not right in Dec or Jan – it‘s only 5% Fed funds rate that‘s priced in so far. Also, markets are thinking the Fed would be forced to start taking rates down in the 2H 2023, but such anticipation seems very premature even if the central bank goes with 50bp this week and 25bp in Jan only.

Remember my early Aug call for inflation to drift to 5-6% – we aren‘t even there yet. And how about the unwritten rule to get Fed funds rate 0.5% above inflation so as to make it restrictive? Taking on the supply side drivers of inflation (crippled supply and excess demand being equally and largest inflation drivers as per Fed‘models) with demand side tools, isn‘t working as fast as the Fed wants, and the still hot labor market (3.7% unemployment rate with 5% nominal wage growth) is also proving sticky this one though would be unrecognizable by the end of 2023 as at least full three points can be added to the unemployment rate easily. Don‘t forget the declining participation rate effects either.

So, the Fed is going to be stuck with sticky inflation and high commodity prices even if base metals and agrifoods are likely to do better than energy over the months ahead. The Fed hasn‘t yet gotten restrictive, and markets with all their retracements of hits taken (such as Friday) are betting it wouldn‘t – the pivot hopes are still central to the bullish case at and beyond the Santa Claus time.

It‘s ultimately a conflict between how deep and widespread toll the current tightening would take it‘s about the Moynihan and Dimon viewpoints. I would argue that the first forecast of an isolated hit somewhere where it doesn‘t hurt or spread that much, with the Fed then saving the day through easy money, is a too optimistic one. The fact that so many on Wall Street are predicting earnings to grow above inflation at the most narrow margin in 40 years (6% over 5%, equalling 1%), with this being the bullish case, tells you a lot about the challenges we are to face next year.

JPM‘s more realistic scenario assumes a tougher recession, one on the quite immediate horizon. One that wouldn‘t be easy to solve through liquidity injections. One that would bring down earnings, labor market and inflation more than anticipated. PMIs at this level never misindicated a recession, and yield curve inversion is highest since early 1980s. Hard landing if you will, with the Fed not blinking, and not cutting rates after Jun 2023, but keeping the Fed funds rate at 5.5% (higher if wage growth pressures persist and odds are they would surprise the central bank still as we‘re in an environment of sticky inflation and rising yields, so don‘t overstay your long TLT welcome).

In such an environment, Santa Claus rally has a tough job running, running far. It needs CPI slowdown to beat expectations, and then the Fed to do 50bp only as priced in. With the statement and conference, any words would be good to grasp at in a Hail Mary bullish fashion.

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Let‘s move right into the charts.

S&P 500 and Nasdaq outlook


All it takes is one bad misstep Tue and Wed, and 3,905-3,910 support gives way, opening 3,880 then. Relative outperfomance of industrials, materials and financials would save the bulls, and open the way for some final 2-3 bullish weeks weeks this year.

The below described credit market move favors the bulls for today no anticipation yet of when and how this retracement of Friday‘s sharp reaction, ends. The sputtering, that‘s the key word, sputtering rally can get an ally still, provided the Fed plays ball but don‘t pin your hopes for targets too high.

Credit markets


Not a good daily close, not at all, but quality debt will make up for that right next. What‘s required, is for junk corporate bonds to join in as well the sentiment can‘t sink on more hawkish Fed bets.

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