Disinflation Hovers Gently On The Mind Of Traders As The Bear Market Rally Gathers Followers — What Fixed Income, Currency & Commodity Markets Are Telling Us
This morning’s US GDP report has stoked the bulls on hopes disinflation has finally arrived and a Fed pivot is in the making. The counter-trends are numerous and will eventually fell this bear market rally, but for now the bears are whipped and continuing to cover their short positions. The volatility risk premium is pointing to a range-bound market over the next few days, while my technical reading of key stocks in the S&P 500 is bearish. Yesterday's cross-asset action brought several positive factors for US stocks. Copper's chart is signifying global growth. The action in major currencies indicates the $US is weak. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to rise modestly over the next few days before falling back to earth in November.
Bonds are rallying on sparse signs of disinflation and exhaustion with the notion that pass-through of input costs and labor shortages will keep inflation persistently high. Notwithstanding earnings reports that confirm the pass through effects, and resilient consumer spending that implies an inflationary mindset, bonds are rallying as the shorts cover their positions. Bond market volatility has declined and suggests the rally has legs, but still remains high enough that I forecast a return to the lows of two weeks ago sometime in November.
The strength in DM and EM currencies isn’t uniform or robust, and I see the $US resuming its rally in November as well. While the $US may not have much higher to go due to purchasing power metrics, only a stronger Chinese economy or a steep drop in fossil fuel prices can shift sentiment toward holding non-$US cash in the intermediate term. Inane politics in China, the UK, the EU and Japan make that unlikely, and capital flight from these nations is a greater threat than a relative decline in the US economy.
Instead of a steep decline the US is more likely to face stagflation in the near term that bleeds into a long and moderately deep recession through the first half of 2023. The Fed will remain hawkish as disinflation is unlikely to come soon enough to alter the inflation mindset among consumers. Commodity markets are also hampering the disinflation process, with fossil fuels rallying, foods and softs almost uniformly consolidating, and metals are trying to break out to higher levels. While corporations maintained earnings in the 3rd quarter their guidance has tilted negative and implies the inflationary mindset will eat away at margins and the ensuing recession eat up sales. That makes a for a long bear market with fresh new lows in November.
My current positions are unchanged from yesterday morning, and include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the inverse levered ETF SPXU, all of which nets out to a meaningful short position in equities.