SPX500 on the Back Foot Ahead of US CPI Inflation & the Latest Earnings Season

Inflation, Recession Fears & Monetary Tightening

The Federal Reserve embarked upon an expeditious monetary tightening path during the second quarter in order to combat surging inflation, having already delivered 150 basis points worth of rate hikes. This culminated in June, when officials decided to increased rates by 0.75%, which was the biggest upward adjustment in nearly thirty years.

The historic decision came after US CPI Inflation had jumped to 8.6% and the highest levels since December 1981. The latest Consumer Price Index data are due on Wednesday, two weeks before the Fed's next policy meeting, with last week's minutes, as well as remarks from Mr Powell and other officials, pointing to a 50 or 75 basis points rise in interest rates.

High energy prices, global supply chain disruption, the Covid-19 situation in China and of course the tightening monetary environment, have sparked fears of stagflation and recession. However, the Fed has largely dismissed these fears, with Governor Waller for instance calling them "kind of overblown" last week ^[1], while Mr Bullard expressed confidence on Monday that the bank can bring down inflation without disrupting the economy. ^[2]

SPX500 Analysis

The Fed's aggressive and front-laded rate hike cycle and the relevant recession fears have led the US stock market to an abysmal second quarter. SPX500 ended June firmly in bear territory, since it had erased more than 20% from its January record highs.

The new quarter started a bit better, but the attempted rebound was contained by the EMA200 (black line) and has a poor week so far. As such, it remains vulnerable to the June 2022 lows (3,637), but bears will likely need fresh impetus for that, which could open the door towards and beyond 3,501.

The current month is positive so far and SPX500 may get the chance to take another crack at 3,900-19, above which near-term bias would pause. However, the upside looks unfriendly and sustained improvement in sentiment would be required for SPX500 to challenge the descending trendline from the March highs (4,060-70).

Earning Season Kicks-off

Against this backdrop, markets will not only focus on inflation, but also on the latest earnings season, which kicks-off this week. Big banks are the ones the get the ball rolling and Wall Street seems to be bracing for a hit to their bottom lines.

Higher interest rates are generally considered good, but banks mostly care for longer term rates, not shorter-term ones, which are the ones boosted by the Fed's front-loaded hiking cycle. This has caused an inversion in the yield curve, with the 2-year ones being higher than the 10-year ones at the time of writing, which is often viewed a sign of impeding recession.

Kansas City Fed President Ms George who had dissented in the June meeting, expressed some concern on Monday around the aggressive tightening pace and warned of "implications for the yield curve and traditional bank lending models". ^[3]

JP Morgan reports on Thursday, but this week our focus will be on Delta Airlines Inc which reports on Wednesday. The airline and travel industry has been recovering from the Covid-19 shock and after a solid first quarter, Delta recently upgraded its Q2 projections, seeing Revenue fully restored to the pre-pandemic Q2 2019 levels. ^[4]

However the industry still faces challenges from high energy prices and the recent chaos witnessed in airports around the world and the flight cancelations by many carriers.

Next week, attention turns to the tech sector, with Netflix and Tesla Motors Inc standing out, which we covered in our recent Top 10 Stocks for Q3 2022 – Part 1 article.