That in and of itself isn’t a positive, but as shown in Figure 2, market-based inflation expectations are highly correlated with commodities, especially oil, and those also appear to be rolling over recently, with the two-year breakeven implied inflation rate recently hitting its lowest level in four months.
To be clear, we do believe that fundamentals still matter, but it would be naïve to suggest that the Federal Reserve (Fed) and the potential path of its rate hikes have not been the primary focus of short-term market moves this year, and so far, that shows little signs of changing. Any shift towards a more dovish Fed, whether it be from economic weakness or lowered inflation expectations, is almost certain to be a positive for bonds, which have fallen dramatically amid the latest surge in inflation and skyrocketing interest rates, but may also be a positive for equities which seemed potentially already priced for a recession.
Conclusion
Scott Brown, CMT, is a technical market strategist at LPL Financial. Quincy Krosby is chief equity strategist at LPL Financial.
So far in 2022, energy investors have been some of the only equity holders rewarded, with the sector up approximately 30% year to date, and the only S&P 500 sector in positive territory. While we remain positive on that sector and do not see a dramatic reversal lower in crude prices, any easing of the constant upward pressure on energy prices like we have seen recently could still allow energy companies to thrive, while providing relief to consumers and the current inflation dynamic. Expectations are just that, expectations, but if the commodity price decline combined with easing supply chain issues can bring inflation lower over the second half of 2022, things may turn around quickly for both stocks and bonds.