A big week ahead for equities on CPI and FOMC A big week ahead for equities on CPI and FOMC A big week ahead for equities on CPI and FOMC

A big week ahead for equities on CPI and FOMC

Peter Garnry

Head of Equity Strategy

Summary:  Sentiment remains bullish in equities with last week's performance driven by strong broad-based gains in commodities and continuous animal spirits in US technology stocks and especially our bubble stocks basket. If tomorrow's US May inflation report delivers a lower than estimated core inflation then it could bolster the "Fed pause" narrative and extend momentum in technology stocks. A melt-up scenario cannot be excluded at this point.

Key points in this equity note:

  • Animal spirits are roaring back this year and recently we are seeing bubble like dynamics as our bubble stocks theme basket is beginning to be among the best performing baskets again.

  • A positive surprise tomorrow in US May inflation figures on the core inflation could bolster the “Fed pause” narrative adding fuel to the already red-hot rally in US technology stocks.

  • The FOMC is priced for no change to the policy rate on Wednesday, but for equities the decision is less important as the real risk is economic data (recession and inflation) more than whether 25 basis points in the policy rate.

The speculative fever is back and it could get crazier this week

Last week was all about hot commodities and bubble dynamics evolving further in equities. Commodities were higher across the board last week due to talk about Chinese stimulus, weather conditions negative impacting expected crop yields, and higher energy prices off OPEC+ cuts (although these gains are quickly being faded by the market). The strong commodity markets lifted our commodity basket by 3% last week making it the best performing theme basket.

The second strongest gainer was the bubble stocks basket which reflect investors’ increasing positive optimism on nonprofitable technology companies. This comeback has been fueled by the AI hype, but EV stocks have also contributed to the stronger risk sentiment in this part of the market. Staying with the electric vehicle theme it is interesting to observe how weak oil has been given that US nominal GDP growth is still at 7%. In fact, this is the weakest oil market since 1984 at this level of nominal GDP growth suggesting two things. Either EV adoption is already to hurt marginal oil demand earlier that previously projected, or the oil market is still a good signal that will soon prove that GDP growth will slow further.

Russell 2000 ETF | Source: Saxo

A positive surprise on inflation would be rocket fuel for equities

The first real test of sentiment in equities will be tomorrow when we get US May inflation figures at 12:30 GMT with consensus looking for the headline CPI m/m to drop to 0.2% from 0.4% in the previous month, while core CPI m/m is expected to remain at 0.4%. The market’s US 10-year inflation swap, which is contract where cash flows are exchanged between two parties against the CPI Index, is still anchored at 2.5% which is slightly above the average since 2004. In other words, the market is still not pricing in a different long-term inflation regime. As our clients would know Saxo’s position has been very different since early 2021 where we have argued again and again that the fragmentation game and the green transformation will be very inflationary over the decade of transition.

For equities the best news would be a positive surprise to the core inflation as that would bolster then narrative of a Fed pause in the policy rate which would likely go straight into the animal spirits and the price action we observe in the bubble stocks. Our latest equity notes The AI hype feels like an echo from past bubbles and Equities signal calm waters, or do they? outline the bubble dynamics in equities as of today. There is an increased index concentration, bubble stocks are performing well, and we see equity options volatility coming down massively.

Tesla share price | Source: Saxo

A Fed pause in sight?

On Wednesday night, the FOMC rate decision will grip markets with consensus looking for no rate hike, and then 60% probability for a rate hike at the July meeting according to Fed Funds futures. The Fed economic projections are likely to show higher expected growth in 2023 and lower unemployment rate compared to the previous projections. In addition, the median dot plot will likely highlight one more rate hike before the peak is reached with the target range set to 5.25-5.50%. The key question for the market will then be whether the economy can absorb the new policy rate and even grow at a healthy pace without slipping into a recession. The Fed maintained roughly this currently policy rate for around four years during the period 1995-1999 in which the US economy was able to grow and corporate earnings did well, and at least not stopping a bubble in technology to form. Another scenario is the 2006-2007 period in which the Fed paused around mid-2006 with equities and the economy continuing higher all the way through to the end of 2007.

For equities the lessons over the years have been that there are moments when policy decisions mean a lot to equities, but the vast majority of the time it means little. This time is not the big pivot point for equities as they relate to the policy decision. What matters the most for equities are whether we get a recession or not, and right now equities are pricing in that a recession is not very likely, or if we get one it will be a mild one in relative terms with nominal GDP growth still around 6%.


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