Indices in Positive Territory, VIX hits new low, despite Bank Failure

It’s Fed Week on Wall Street and will occupy the primary focus of traders until at least Wednesday afternoon, when traders are finally able to hear more about the longer-term intentions of the central bank. Markets shrugged off JP Morgan’s acquisition of First Republic Bank, the biggest bank failure since 2008. This morning's economic data came in as good as, or better than, expected. The VIX, Wall Street’s fear index, continues to decline and indicate a pretty sanguine outlook.

We invite readers to take a look at our recent research on equity market valuations, ‘Are equity markets too relaxed?’

What To Expect from the Fed

Wall Street fully expects one more rate hike from the Fed this week, followed by a pause, before seeing a couple of rate cuts later this fall. In other words, Wall Street is convinced that we will see a pivot this year, with the last of the rate hikes coming this week. Fed fund futures this morning put 92% odds of a 25-basis-point rate hike on Wednesday of this week.

Wall Street may finally be right, after being wrong for much of the past 15 months, although several risks remain in place that could still give us additional rate hikes. For us, the bigger question is the timing of the first rate cut. Keep in mind that this Fed has discussed at length the negative implications of a premature rate cut back in 1980 that it considers in hindsight to have been a major mistake. That premature rate cut in 1980 necessitated aggressive rate hikes later in the same year, pushing rates upward toward 22% briefly, to bring inflation back under control.

What the Fed expects for Inflation

The whole point of the rate hikes is to inflict sufficient pain on the economy for long enough to bring the core reasons for inflation under control sufficiently to bring the overall inflation rate down to the 2% mandated level. We do not believe that the Fed has yet done that, nor that most Fed members believe that they have either. The US economy faces multiple inflations challenges: wage inflation, higher oil prices, and a housing market showing signs of recovering.

Hitting the 2% mandate may not mean additional rate hikes, although that is still possible, but it does likely mean holding rates for longer than the market currently anticipates. We should soon start to see the unemployment rate start to tick higher, which is a necessary component for taming wage inflation, but the amount of stimulus still in the economy leaves it vulnerable to a quick rebound if the Fed takes its foot off the brakes too quickly.

Commodities Fear Recession

Wall Street may be pricing in an economic recovery, but the commodity market is currently focused on anticipated lost demand in the future anticipated recession. That sentiment will change one day, although the timing is yet to be determined. We are monitoring the crude oil market as that is where a sentiment change might first appear. Crude oil demand is the first to show lost demand in a slowing economy, and it should be the first to see a flip in the fundamentals as the economy recovers as well.

Indices rally, VIX hits new lows

• At the time of writing, the broad S&P 500 and NASDAQ indices were up by 0.4% and 0.2% respectively, at 4,186 and 12,253
• The VIX, Wall Street’s fear index, fell to 15.6 mark (another historic low)
• The dollar index was notably higher, ahead 0.5% at 102.2
• Yields on 2- and 10-year Treasuries fell rose to 4.12% and 3.55%, respectively

Oil and Gold fall

• Gold prices dipped below the $2,000 per ounce mark, to $1,991
• Crude oil prices fell 1.8% to $75.4 per barrel
• Soybean prices were stronger, posting modest gains across the board following last week's collapse
• Wheat prices are trading seasonally weaker, with traders no longer worried about the drought in the Plain
• Corn prices tried to hang with soybeans, but big double-digit losses in wheat made that difficult

Analysis by Arlan Suderman, Chief Commodities Economist

Contact: Arlan.Suderman@StoneX.com