Inflation Graphic

Treading the Inflation Data

It was a busy week on Wall Street as the inflation data disappointed and the yield curve shifted higher putting pressure on the stock market. There are now three months in a row where inflation data looks to be settling down near 3% which is higher than the Fed’s 2% target. This should put the Fed in a neutral stance until inflation data improves or the economy falters but they may cut anyway.

Gains and Losses of Bank Securities

Why? Because there is a concern the lagged effect of rising interest rates will cause a credit contraction and cutting now would soften the blow to the economy.

Or, they may cut too soon and spark another rise inflation defeating the purpose of their hawkish policies. After all, there is now a brewing problem with debt service in commercial real estate, high-yield bonds and now the Federal Government as interest rates are now higher. You can see in the above graphic how banks are now sitting on paper losses in the aftermath of rate hikes.

Credit problems and higher interest rates will ultimately drag economic growth lower but the timing is too ethereal right now for the Fed to confidently anchor a policy change. In other words, something has to break first.

To The Pain

The interest rate complex is the nexus between many things in the global economy and below we have the US 10Yr Treasury yield. You can see the path of interest rates look like a stock chart that is headed up and to the right. We did hit a peak last October(4.993%) and now we are taking a break from this uptrend in a corrective move which should ultimately get the 10Yr below 4% before making new highs within the next few years.

10Yr Treasury Yields

In the near term, 10Yr yields are moving higher in wave ‘B’ which could get the 10Yr close to the previous high near 5% in the coming weeks. We will have to wait and see what the catalyst is for a reversal to lower levels. If I am wrong and the 10Yr goes well above 5% this year then we will probably see a break down in stocks and that could be the catalyst that causes the Fed to drop interest rates.

An Overbought Stock Market

The expectation of many rate cuts in 2024 fueled the rally from the November 2023 low and now the window is closing on that scenario as the progress to lower inflation has stalled. The Fed can do what it wants but the momentum in equities is getting tired and we have seen down closes for the last two weeks. The momentum indicators are curling lower at the bottom of the chart so we may have some choppy trading in the coming weeks.

S&P 500

Hard to call a big correction right now but the potential is there if something breaks and the Fed can’t clean it up.

Paul J.McCarthy

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Paul J McCarthy III CFA

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.