Fireworks Season

The next few months will weigh heavily on the financial markets. Economists and portfolio managers will continue to parse inflation and growth data for clues on where interest policy may go and don’t forget that weaker data means a flirtation with a recession.

Yield curve by @kiscocap.

Although a slowdown is what the Fed wants to tame prices, it is hard to hit the brakes once a slide towards a contraction begins. We have a June and July FOMC meeting before election season goes in high gear where the Fed typically sits on the sideline. If growth and/or inflation data diverges from expectations then it is likely we see volatility come into the equity, interest rate and currency areas. Keep in mind that the yield curve remains inverted and how it returns to a steep curve (long yields are higher than T-Bills) is the question most bond traders are trying to answer. Eventually, we will find out the answer but the soft landing scenario is largely considered a low(er) probability by the fixed income market.

On Friday, we got the Personal Consumption Expenditures (the Fed’s favorite inflation measure) for April and that came in as expected at +2.7% which is close to the 2% target. However, some of the consumer spending and income data looked a bit weaker and there is concern this may deteriorate over the summer months. Also, we get durables goods orders and the jobs data for May next week so the market will have something to chew on before the Fed meeting on June 12th.

Watching the Tape

We have seen some decent opportunities in growth names over the past few weeks but overbought conditions warn these names are running out of gas as we head into June. The S&P 500 in the chart below has stagnated for three weeks. Also, there is a negative divergence building on the RSI at the bottom of the chart which warns upside momentum is waning. We had a good burst of buying in the last hour of trading on Friday so we will see if that carries over into next week but the S&P is in a vulnerable spot.

SPY ETF by @kiscocap.

The 10-Year Treasury Yield

The yield on the 10Yr Treasury has been steadily rising since a low ‘A’ (3.77%) was established last December in the chart below. It looks like we will see this countertrend move end once 10Yrs move above 4.75% which should complete the ‘B’ leg where maybe we see 5%. If I am right, yields should then begin to drop below 4% but that is probably next year’s business.

10Yr Treasury yield.

Of course, this is a chart-pattern that may need modifying down the road and it doesn’t explain what the catalysts might be to cause yields to fall in this fashion. There are numerous possibilities such as inflation abating, the Fed cutting rates or maybe growth falters and there is a flight to quality away from riskier assets such as stocks and high-yield bonds. It does seem an answer is on the horizon and I don’t think it comes from a Fed meeting (or an election) but we will know it when we see it.

Paul McCarthy of Kisco Capital, LLC

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Paul J McCarthy III CFA

President, Kisco Capital

Paul McCarthy

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