Intraday Market Thoughts

From Flation to Stag & Back

by Ashraf Laidi
May 11, 2022 19:36

Readers of this column went from vaccine "experts" to a Russia connoisseurs and yield curve whiz, while picking up a few nuggets about bear market corrections. So let's move to the more controversial subject of inflation. Whether it's transitory or not is not the question. Today's release of US April CPI showed a long-awaited pullback, printing 8.3% y/y from 8.5% in March-- the first slowdown since August. Here's how it may play out.

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From Flation to Stag & Back - Vvix Vix Spx May 11 2022 (Chart 1)

The CPI pullback emerged largely from slowing energy prices and retreating prices of used autos. Since the former is expected to push back up due to rebounding gasoline prices, deflationistas will hope for an offset from prolonged declines in used autos.

The challenge ahead for traders is to figure out when markets shift their focus from inflation to recession.  The simultaneous accelerating decline in bond yields and tech stocks (around 2 pm Eastern) may have been related to robust demand in the 10-yr auction, but keep an eye on the big picture. Read on…

Gold rebounded $25 from 1832, while bond yields resumed the week's decline alongside fresh selloff in stocks. Apple hit a new low for the year, Amazon broke its 6-year trendline and Netflix extended its losses to -75% from the highs. The stocks-bonds damage to “SuperPortfolios” is officially joining the damage to “WorkingClass” purchasing power to break consumer demand/growth and corrode that wealth effect. 

Recession rumblings were amplified today after CPI went from 8.5% to 8.3%. Imagine what noise the “stag” part will do when “flation” goes from 8.3% to 8.0%...or below 8.0%. Let's not even look at the month-month figures. 

Don't forget the yield curve metric. Many think we need to see another round of inversion to spell recession. Wrong. Any continued steepening from current levels will mean the doves are coming around. But if the 3-5 spread soon drops below zero from its current 0.06 and 2-10 nears 0.10 from 0.28, then it might take a bit longer. 

Currency developments also bear watching. German-US 10 yr spread has continued to stabilize alongside EURUSD, and EURGBP is strengthening its negative correlation with risk assets. Then you have gold, which is fighting to hold above its 200-DMA and August trendline. 

We're not sure what will come first: A sub 5.0% inflation print in the US, or an official recession declaration from the US NBER. But here's my latest call: By the time US CPI drops near 6%, we'd see a steeper yield curve, a more confident Fed (with its inflation-taming efforts) and weaker growth. Metals will get their next wave of vigour once markets realise consumer prices have settled at a higher low. 



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