MARKETS

Stocks wobbled as investors positioned themselves ahead of today’s CPI report.

US IG credit is closing unchanged to 3bp wider, rates rallied, and equities fell (SPX: -0.92%, DJIA -0.62%, NDAQ -0.95%), reflecting the uncertainty investors feel ahead of Wednesday’s US CPI print. Treasury curve inversion deepened to levels last seen in 2007 – 2s10s spread was as low as -12.4bp before ending back around -9bp after the 10-year auction caused a re-steepening of the curve.

Typically equity market can deal with one risk relatively well. But the current setup of sticky inflation, rapid Fed tightening, growth/recession risks, and excessive rates volatility, to name a few, have at times left investors defenceless. And with the market coalescing to a bearish consensus, stocks are having trouble sustaining a meaningful rally.

With some recession risk priced into the market, the multiple should get a slight lift if today’s CPI print finally marks peak inflation; it should mitigate the probability of the extreme bear case of unmanageable inflation and higher rates which could then reframe sentiment in a mild recession The upshot of this: a higher chance of a mild slowdown reduces the likelihood of the extreme bear case under a stagflationary regime.

Also, it seems market-friendly enough that refining crack spreads are declining and gasoline futures look less backwardated. Demand destruction it may be. Still, lower gasoline prices are a pre-condition to the mild recession ‘bull’ case, a massive improvement from the stagflationary bear case that all roads seem to lead through.

Oil Prices

Crude prices fell nearly 8 % to finish at their lowest level since April 12. as  President Biden travels to Saudi Arabia to discuss ways to boost production.

The is no one is smoking gun today for the crude price weakness, but I would say it’s a combination of a few factors.

Oil prices crashed as demand destruction fears grew louder due to new lockdowns in China, sticky inflation, and a strong dollar grabbing the spotlight, significantly ahead of what is suspected to be a hot US CPI print and potentially USD supportive.

Given China’s zero covid policy, a resurgence in China is adding to concerns about a global economic slowdown just as Europe tetters on the brink of a recession and will undoubtedly fall into one if Russian gas stop flowing this month, triggering energy rationing.

The USD continues to strengthen, and crude gets more expensive; it should trigger more worldwide demand destruction as the dollar has reached parity against the euro –1 dollar for 1 euro — for the first time in 20 years.

The US administration is taking two heads are better than one approach to solve the world’s colossal oil price problem. President Biden is in the Middle East pressuring OPEC to bring more barrels as he believes they have more room to raise production. Janet Yellen is in Asia drumming up support for her Russian oil  price cap,

And rounding out the bearish carousel of oil market risk, Heathrow asked airlines to stop selling seats to ease chaos which has negative implications for oil.

FOREX

Given the worries about the European energy supply, recession risk and a hesitant ECB, the overall situation for the single currency is gloomy. The upside potential could be limited, but given the pair started last week on a 1.04 handle in the short term, there could be some short-term gains at some point. And yesterday’s profit-taking rally after .9999 printed was not wholly unexpected. Still, the street will continue to sell into rallies until there is news that Russia’s gas flow will resume through Nordstream 1.

Time-zone analysis shows that most of the euro selling over the past week took place almost entirely during the European session, likely on capitulation by real money investors. Yesterday, Europe was better bid.

Stephen Innes

Managing Partner
SPI ASSET MANAGEMENT