August keeps us wary, but in past week, risk of recession lower and visibility of lower inflation greater. Market increasingly needs to consider Fed could cut rates in early 2024

Today’s note will include a short video update. We discuss:  The fact stocks traded flat on good news does add to our wariness of August.  But odds a recession fell last week and visibility for lower inflation improved.  We think markets will start to focus on fact Fed could cut rates as early as Feb/March 2024 as real rates start surging.

Please click below to view yesterday’s Macro Minute (Duration: 7:22).

So far in August, equities have delivered a terrible performance with S&P 500 down 2.7% and QQQ down -4.5%. It might be glib to dismiss this simply as “this is August” (certainly some truth). What makes us more wary is that last week’s weak equity performance came as we saw good fundamental surprises on July CPI and to an extent July PPI and U Mich inflation.

• There is an adage which is be careful when stocks do not rise on good news. This could mean several things:
  – benign: it is noise
  – medium bad: market is consolidating
  – bad: local top is in and a larger correction is underway
• As we noted earlier this month, when stocks front load weakness in August, the rest of the month tends to fare better. Since 1950, when equities are up >15% thru July and August down first 3 days (n=9), equities tend to gain into month end 78% of the time. So, this remains our base case.
• And this is consistent with Mark Newton, Fundstrat’s Head of Technical Strategy, where he believes the S&P 500 is close to bottoming near term. He cites a multitude of factors including DeMark, cycles, waves and other technicals.
• The next major inflation data point will be July PCE deflator (Fed’s preferred measure) and this will be released on 8/31. While there will be plenty of incoming economic data in coming weeks, equities will also be buffeted by the reduced liquidity of August.
• Increasingly, though, we believe investors will begin to speak about the need for Fed to cut rates in 2024. Anecdotally, it seems the plurality of our clients are not in this camp. Most seem to be in the Fed “higher for longer” with the idea that inflation is sticky and thus Fed needs to stay tight for longer.
• Following the July CPI, our analysis shows we believe the soft readings of +0.2% or less are repeatable and could be seen for the new few months. And a kicker could come if housing prices also cool off and begin to reflect market-based measures.
• Interestingly, if core continues to see +0.15% to +0.20% MoM, core inflation will be below 3% by Feb 2024 and below 2% by May 2024. Progress is not linear, so we are just making an illustration. But the fact is goods inflation is slowing sharply and services inflation is not necessarily picking up momentum. So an average of +0.15% to +0.20% is not so off base.
• If the Fed keeps Fed funds at 5.50%, this would imply a severely restrictive real rate of >3% by May and compared to <1% real now. In fact, >3% real is associated with Fed engineering recessions.
• This is where the obvious question arises. Is the Fed trying to fight inflation? Or are they trying to kill economy? Currently, it seems an inflation war to us, and thus, they will want to lower rates to keep “real rates” not too restrictive. In fact, even NY Fed John Williams made this statement last week, if inflation keeps coming down.
• The idea of Fed cuts in early 2024 would likely be a surprise to markets, even if Fed fund futures imply March 2024 is the first cut. Mostly, we believe long-term rates would not be creeping higher as they have been in the past month if markets really believed the Fed would be cutting in 2024. And we do not think investors would be piling into short-term cash in such vast numbers.
• If Fed begins cutting, money market and short-term rates will soon fall, making these 5% yields only ephemeral. And investors have been piling into money market funds:
  – past 3 weeks
  – Institutional money market cash higher by +$41 billion
  – Retail money market cash higher by +$31 billion
  – combined +$72 billion taken out of risk assets
  – Wow

Bottom line: August still keeps us wary, but the higher probability of Fed cuts supports 2H23 equities

If anything, in the past week, economists would say two things:

• risk of recession diminished given economic resilience
• risk of rising inflation diminished, as global inflation tracking lower

So overall, this is a positive fundamental development for stocks. This is August, so stocks can continue to trade poorly. And thus, we watch for tactical cues from the market to see when equities could turn higher.

Key incoming data August

• 8/1 10am ET July ISM Manufacturing Tame
• 8/1 10am ET JOLTS Job Openings Jun Tame
• 8/2 8:15am ADP National Employment Report Hot
• 8/3 10am ET July ISM Services Tame
• 8/4 8:30am ET July Jobs report Tame
• 8/7 11am ET Manheim Used Vehicle Index July Final Tame
• 8/10 8:30am ET July CPI Tame
• 8/11 8:30am ET July PPI Tame
• 8/11 10am ET U. Mich. July prelim 1-yr inflation Tame
• 8/11 Atlanta Fed Wage Tracker July Tame
• 8/15 8:30am ET Aug Empire Manufacturing Survey 
• 8/15 10am ET Aug NAHB Housing Market Index
• 8/16 8:30am ET Aug New York Fed Business Activity Survey  
• 8/16 2pm ET FOMC Minutes
• 8/17 8:30am ET Aug Philly Fed Business Outlook Survey
• 8/17 Manheim Aug Mid-Month Used Vehicle Value Index
• 8/23 9:45am ET S&P Global PMI Aug Prelim
• 8/25 10am ET Aug Final U Mich 1-yr inflation
• 8/28 10:30am ET Dallas Fed Aug Manufacturing Activity Survey
• 8/29 9am ET June S&P CoreLogic CS home price
• 8/29 10am ET Aug Conference Board Consumer Confidence
• 8/29 10 am ET Jul JOLTS
• 8/31 8:30am ET July PCE

Key incoming data July

• 7/3 10am ET June ISM Manufacturing Tame
• 7/6 8:15am ADP National Employment Report Hot
• 7/6 10am ET June ISM Services Tame
• 7/6 10 am ET May JOLTS Tame
• 7/7 8:30am ET June Jobs report Mixed
• 7/10 11am ET Manheim Used Vehicle Index June Final Tame
• 7/12 8:30am ET June CPI Tame
• 7/13 8:30am ET June PPI Tame
• 7/13 Atlanta Fed Wage Tracker June Tame
• 7/14 10am ET U. Mich. June prelim 1-yr inflation Mixed
• 7/17 8:30am July Empire Manufacturing Survey
• 7/18 8:30am July New York Fed Business Activity Survey
• 7/18 10am July NAHB Housing Market Index in-line
• 7/18 Manheim July Mid-Month Used Vehicle Value Index Tame
• 7/25 9am ET May S&P CoreLogic CS home price Tame
• 7/25 10am ET July Conference Board Consumer Confidence Tame
• 7/26 2pm ET July FOMC rates decision Tame
• 7/28 8:30am ET June PCE Tame
• 7/28 8:30am ET 2Q ECI Employment Cost Index Tame
• 7/28 10am ET July Final U Mich 1-yr inflation Tame

Key data from June

• 6/1 10am ET May ISM Manufacturing Tame
• 6/2 8:30am ET May Jobs report Tame
• 6/5 10am ET May ISM Services Tame
• 6/7 Manheim Used Vehicle Value Index May Tame
• 6/9 Atlanta Fed Wage Tracker April Tame
• 6/13 8:30am ET May CPI Tame
• 6/14 8:30am ET May PPI Tame
• 6/14 2pm ET April FOMC rates decision Tame
• 6/16 10am ET U. Mich. May prelim 1-yr inflation Tame
• 6/27 9am ET April S&P CoreLogic CS home price Tame
• 6/27 10am ET June Conference Board Consumer Confidence Tame
• 6/30 8:30am ET May PCE Tame
• 6/30 10am ET June Final U Mich 1-yr inflation Tame

Key data from May

• 5/1 10am ET April ISM Manufacturing (PMIs turn up) Positive inflection
• 5/2 10am ET Mar JOLTS Softer than consensus
• 5/3 10am ET April ISM Services Tame
• 5/3 2pm Fed May FOMC rates decision Dovish
• 5/5 8:30am ET April Jobs report Tame
• 5/5 Manheim Used Vehicle Value Index April Tame
• 5/8 2pm ET April 2023 Senior Loan Officer Opinion Survey Better than feared
• 5/10 8:30am ET April CPI Tame
• 5/11 8:30am ET April PPI Tame
• 5/12 10am ET U. Mich. April prelim 1-yr inflation Tame
• 5/12 Atlanta Fed Wage Tracker April Tame
• 5/24 2pm ET May FOMC minutes Dovish
• 5/26 8:30am ET PCE April Tame
• 5/26 10am ET U. Mich. April final 1-yr inflation Tame
• 5/31 10am ET JOLTS April job openings

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