Market expectations

Amid a somewhat dovish stance from Fed members, risk assets surged last week while the US dollar index experienced a partial uptick, nearing 106 before encountering resistance. Investor caution prevailed ahead of the impending US inflation data release, keeping the greenback at a standstill.

Inflation remains a pivotal focal point for the market, with the Fed warning that any deviation from the downward inflation trend or robust growth data might trigger a return to interest rate hikes. Conversely, a divergence from expectations could prompt the currently vigilant Fed to adopt a more hawkish rhetoric, potentially spurring heightened demand for the dollar.

Soft CPI ignites short squeeze in bonds, propelling stocks higher

Following the CPI report, a rally ensued in the stock market as falling energy prices offset the net rise in health insurance and medical impacts. The S&P 500 surged by approximately 1.9%, closing near 4,490. This unexpected surge deviated from historical trends and defied initial expectations. Remarkably, rates plummeted significantly, particularly in more leveraged and short areas of the market.

The downward movement in the 2-year rate suggests an anticipated pricing of rate cuts, while the reshaping of the yield curve, leaning towards a steeper slope, becomes increasingly crucial given indicators of economic softening. Now retail sales figures assume critical significance amid this shifting landscape.

Markets challenge key levels and highs

The latest inflation data fueled substantial gains across indexes, with the Russell 2000 (IWM) leading the charge, surging over 5%. Clearing its 50-day MA and surpassing the last swing high on higher volume accumulation, the index displayed remarkable strength.

The Nasdaq advanced over 2% and is poised to challenge the August swing high, shaping up a promising base on its right-hand side. The S&P 500, already surpassing the November swing high, is in the process of confronting the August swing high. Tuesday’s gains are pivotal in solidifying a strong bottom across indexes, potentially marking the end of market declines.

US 10-Year yield: Retreat signals market expectations of Fed pivot soon

The fair value estimate of the US 10-year Treasury yield suggests the current market rate is unusually high and anticipates an imminent narrowing of the spread. A sharp decline in the 10-year yield, triggered by favorable October inflation news, hints at the commencement of normalization. The market’s perception of a lofty and possibly unsustainable 10-year yield appears to be shifting, indicating the start of a normalization process.

Catalysts contributing to this shift include the expectation that the Federal Reserve might conclude rate hikes for this cycle. Positive inflation updates further strengthen the case for a potential pause in Fed rate hikes, potentially aligning with market sentiments of an early 2024 easing.

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