Risk-off environment accelerates on increasing growth concerns

Thoughts

• Equity markets are poised to extend their declines Monday on a breakdown in technicals, with the S&P 500® Index set to break through the May lows and officially enter bear market territory. The S&P 500 is heading down for the 10^th time in 11 weeks, though there are few signs of capitulation, with the VIX at just 33 and the put/call ratio at 1.3. Additionally, domestic equity funds have seen inflows in five-straight weeks, with the year-to-date total at over $120 billion, suggesting the retail investor remains in “buy-the-dip” mode and is not sufficiently fearful to generate a market bottom. Despite the technical breakdown, underlying fundamentals (including consumer spending and corporate profits) have not yet broken down.
• The risk-off environment is even extending to the Treasury market, with broad selling and curve flattening. The 10-year Treasury yield spiked to the highest level since 2011 at 3.27% Monday morning, though the 2-year is rising more rapidly, up 0.41% since Wednesday, and at the highest level since 2007. The flat yield curve reflects fears of a Fed policy error and an impending recession. The dollar index continues to rally on higher rates and a flight-to-quality, now 10% higher for the year. Bitcoin is collapsing on word that crypto lender Celsius is not allowing withdrawals, driving Bitcoin to the lowest level since 2020.
• As long as consumer spending and earnings remain stable, if we forecast out 12 months from now, we think right now will show to be a good buying opportunity; however, investors should expect more volatility and pain as we find the bottom.

News

• All eyes will be focused on the FOMC meeting this week, with the CPI reading increasing the odds of a 0.75% hike to over one-in-four from just 3% a week ago. An FT survey of economists shows a 70% chance of a recession next year. Consumers are historically cautious, with consumer sentiment at a record low of 50.2, driven by roughly equal weakness in current conditions and consumer expectations. Consumer spending levels are not consistent with a recession, but there is an increasing belief that historic weakness in sentiment will lead to more cautious spending.
• The consumer price index unexpectedly accelerated in May, dashing hopes for peak inflation. CPI rose 8.6% from a year ago, above the consensus estimate of 8.2%, and at the fastest pace in over 40 years. The pain was broad-based, led by surging food and energy, reaccelerating used car prices, and shelter costs (nearly one-third of the CPI calculation) at the fastest rate since 1991. Core CPI (excluding food and energy) also surprised to the upside at 6.0%, though it is below the 6.4% peak in February. The implications on the consumer are substantial, with inflation exceeding wage growth by 3%. The bond market reacted to the report, with the Fed Funds futures curve now embedding 0.50% hikes at the next three meetings and the 2-year yield at the highest level since 2007.
• Global growth concerns are growing, with the World Bank cutting the growth forecast for 2022 by 1.2% to 2.9% in the latest Global Economic Prospects report. The Russian invasion of Ukraine is putting pressure on growth, “leading to high commodity prices, adding to supply disruptions, increasing food insecurity and poverty, exacerbating inflation, contributing to tighter financial conditions, magnifying financial vulnerability, and heightening policy uncertainty.” The Japanese government and BoJ officials issued a joint statement expressing concern over the rapidly deteriorating yen (20-year low) ahead of the BoJ meeting last week, leading to possible currency intervention. The ECB made hawkish comments at their meeting the previous week, causing economists to revise expectations for rate hikes from the current level of -0.5%. The Council announced it intends to raise rates by 0.25% in July and September and end the bond-buying program in three weeks.

What to Watch

• The FOMC meeting will be the primary focus of investors this week, including a press conference by Chair Powell on Wednesday. Economic releases include PPI and NFIB Small Business on Tuesday, retail sales on Wednesday, housing starts on Thursday, and industrial production on Friday.