Bearish thoughts into the Weekend
The gap between growth deterioration and Fed's ability to address it is too wide for risk markets at this point. Expect Fed pushback next week to market pricing to kick off another bout of risk off
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It was a good press short this morning after the very crappy services PMI which showed contraction for the first time since Covid was raging in early 2020.
Ultimately, as I have been discussing, there is gap between the reality of the economy which is slowing amidst still high inflation and the Fed's ability/desire to address this slowdown in growth ahead of a break in inflation. We have seen a strong rally in risk assets over the last few weeks on back of the market front running the Fed's reaction function, with a belief that the Fed will pivot quickly in a slowdown even with elevated inflation readings. That has manifested itself in the market removing several rate hikes, lowering the terminal rate and pricing in nearly 100bps of rate cuts beginning early in 2023. However, with inflation still above 8% now and expected to be in the 5-6% range in 1Q23 (inflation swaps pricing) and the unemployment rate still below 4%, the idea that the Fed is ready to not only pivot its tightening agenda but then immediately cut rates seems ridiculous to me. So now we have this gap of where market's are pricing rates for next year and the Fed's ability to actually deliver that level of easing. In my view, the market at SPX near 4000 has significantly front run the Fed's ability to ease financial conditions enough to address this growth deterioration with still too high inflation. More likely what needs to happen now is that risk markets need to start begging the Fed to deliver those cuts and the way to do that is through a risk asset correction. I would expect next week the Fed to further cement inflation elimination as its primary goal which will extend the timeline once again for a Fed pivot and as a result, I continue to believe that risk markets are looking forward to a significant negative repricing lower in the next several weeks as markets come to grips with the reality of a Fed that is not able to deliver easing at this point in the cycle. The old market adage that you don't buy the first rate cut into a recession, but rather you buy the last one, still holds true.
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