Emotional swings continue as the FOMC meeting looms

Thoughts

• Equity markets seek to continue their bounce, after showing gains for the first time in four weeks. Investors appear to have come to terms with the Fed’s resolve to curb inflation, while global markets are reacting to progress in Ukraine’s fight against Russia. This is causing the euro to rally against the dollar. The rally was broad-based, with nearly equivalent gains in large and small caps and in growth and value. Other risk assets are rallying, including Bitcoin gaining 15% since last Tuesday. The durability of the rally will likely be determined by Tuesday’s CPI report this week and the tone of the FOMC meeting next week.
• For much of the year there has been a divergence between the sentiment of retail investors and their behavior, with investors allocating a net $167 billion to equities this year despite persistent bearishness in surveys. Sentiment continues to be weak, as the AAII survey shows just 18% bullish, marking the lowest reading since April and below the long-term average for the 42nd consecutive week. Bears at 53% outnumber bulls by three-to-one. Flows turned negative in the most recent week, with U.S. funds losing $11b in the worst week in 11 weeks. Institutional investors remain pessimistic, and their positioning is conservative.
• Institutional investors remain cautious, and retail investors are showing signs of capitulation. With near universal pessimism and substantial negativity priced into markets, strength over the past week indicates a shift may be coming.

News

• Comments from Fed officials last week reinforced their commitment to keeping policy tight to tamp down inflation. “We need to act now, forthrightly, strongly as we have been doing,” Chair Powell said Thursday. “My colleagues and I are strongly committed to this project and will keep at it.” The Fed Futures curve embeds an 88% chance of a 0.75% hike later this month, with a peak in the Fed Funds rate at roughly 4% (currently 2.5%). The curve, however, continues to project cuts to the rate beginning next May, which seems optimistic given the tone of Fed officials and the math around getting inflation back close to their 2% target. Inflation data will be in focus this week, with consumer price inflation on Tuesday and producer price inflation on Wednesday. Economists predict the first month-to-month decline in CPI since May 2020 after a flat July, though the year-over-year pace will likely exceed 8%. Core CPI will likely grow, as the headline number benefits from falling gas prices, and shelter prices increase.
• As the third quarter heads for a close, investors are beginning to increasingly focus on earnings pressures. The current consensus shows 4% growth in the third quarter on 10% revenue growth. That reflects continued margin pressure from labor availability, commodity pressure, and supply chain issues. The consensus for 2023 has begun to decline, losing 3% in the past few months, though growth remains at 8% driven by 4% revenue growth, betting that margins recover next year. Downward revisions have stabilized over the past month, though pressure is likely to rise over the next month.
• Global economic data remains challenged, with the European Central Bank voting to hike the deposit rate by 0.75% from 0%, with President Lagarde hinting that several additional moves are coming. The Bank of England postponed its meeting where a rate hike was expected following the death of Queen Elizabeth. Economists predict Europe is heading for a recession, with Bloomberg data showing the probability of a recession in the next 12 months at 55%. Officials in Europe are calling for price caps on Russian gas, while the U.K. passed a measure to subsidize consumers’ energy bills. CPI in China fell to just 2.5% on depressed spending from COVID and drought-driven shutdowns, driving calls for accelerated stimulus from the government.

What to Watch

Tuesday’s CPI report and Wednesday’s PPI will be the primary focus of investors this week. Other notable releases include NFIB Small Business and hourly earnings on Tuesday, retail sales and industrial production on Thursday, and consumer sentiment on Friday.