The cooler-than-expected US inflation reading for July is a positive sign that has buoyed risk assets, but some investors may be getting a little ahead of themselves, according to analysts.
The rally that sent the S&P 500 to a three-month high and the Nasdaq 100 more than 20% above its June bottom was fueled by bets that the Federal Reserve may turn less hawkish on interest rate hikes. Yet market observers cautioned that policy makers will want to see months more of evidence that price gains are slowing before they change their view.
European stocks gave up most of an initial advance Thursday after surging to the highest in two months following the CPI report. US futures were also off their highs for the session.
“We were pricing a much more severe slowdown than we’ve seen so now it’s repricing for a different outcome,” said Michael Antonelli, market strategist at Robert W. Baird & Co. “That doesn’t mean we race back to all-time highs, just means that the worst-case scenario of a hard landing is fading into the rear-view mirror.”
Here are some comments on what’s next for markets:
4% Fed Rate
“The markets reaction is undeniably positive, but we think overdone,” said John Velis, an FX and macro strategist at Bank of New York Mellon. “We still think the Fed will move rates up close to 4% by the end of the year or beginning of 2023, and that inflation, while decelerating will remain uncomfortably high.”
Policy-Rate Plateau
“The CPI release does not indicate a pivot to dovishness for the Fed. It reduces the risk that dramatic moves such as raising the target rate by 100bps in September or an inter-meeting hike will be needed,” Sarah Hewin and Steve Englander, at Standard Chartered Bank, wrote in a note. “We expect that by Q4-2022 the evidence of economic slowing will be enough to lead to a pause, but the now-priced-in 2023 policy rate cuts will become a policy-rate plateau.”
Volatility Targeting
“VIX is trading below 20 for the first time since April and VIX term structure has steepened to the highest levels since April,” said Chris Murphy, derivatives strategist at Susquehanna International Group. “Lower volatility levels could open the door for more equity buying from the vol targeting community.”