Well in case you didn’t notice, Thursday brought still more evidence that price pressures are building in the U.S.
Here’s the Empire State Manufacturing prices-paid index, which jumped 12.4 points to its highest since 2012 in February:
“Input price increases picked up noticeably, with the prices paid index reaching its highest level in several years,” the survey notes.
Additionally, the core PPI numbers were a beat (0.4% m/m against consensus of 0.2% and 2.2% y/y against consensus +2%).
Exactly none of this does anything to counter the Fed narrative or to reduce upside Fed risk which got more upside-ish with Wednesday’s CPI print.
I mean obviously, there’s always a way to spin the narrative to fit your outlook, but I’m not sure that’s what’s going on with equities. I think maybe people don’t understand what the likely outcome of rising inflation and expansionary fiscal policy is likely to mean in terms of pulling forward the end of the cycle and giving the Fed a “motive for murder” – so to speak.
I talked to so many people on Wednesday and read so much commentary that I reached that saturation point where I couldn’t find my way out of the weeds to construct a 30,000 foot view, but today I’m pretty confident in reiterating the notion that equities just don’t seem to be convinced that the Fed is going to risk breaking with the gradualism theme no matter what the data is saying.
There doesn’t seem to be any easy way out of this. Either fears of a more hawkish Fed in light of rising price pressures materialize or they stick with a gradualistic approach and well telegraphed policy which risks the curve bear steepening aggressively (especially in light of batshit crazy fiscal policy and questions about foreign demand for new supply from Treasury).
Either way, the risk-reward to piling into equities seems decidedly poor especially against what looks like a backdrop that’s becoming increasingly conducive to manic trading and hyper-sensitivity to “bad” news – or really just any news.
For their part, Barclays sees three possible outcomes for stocks: “1) A further leg down (low but non-zero probability); 2) A gradual reversion to normalcy (VIX returning to low teens over ~ 2 months; 3) A very rapid reversal which could lead to a melt-up rally with a ‘market up volatility up’ dynamics similar to the late 1990s.”
Note that would also be “similar” to January in terms of “spot up, vol. up.”
Barclays goes on to note that “during past volatility spikes of similar magnitude (2010, 2011 and 2015), the VIX took several months to normalize [and] indeed during 2010 and 2011 the VIX returned back to the low teens only after six months.”
Of course the longer the post-crisis policy regime persisted, the more rapid the vol. spike/SPX dip reversals became – or more colloquially, the more efficient the dip-buying mechanism worked.
For their part, Barclays thinks that if the “mean reversion” in vol. happens too quickly, it could set the stage for (another) melt-up in stocks.
“If the normalization is extremely rapid, that would indicate that ‘animal spirits’ are back [and] this might herald the start of a ‘melt-up’ or ‘bubbly’ rally since given extended valuations the rally is likely to be quite volatile,” the bank writes.
Obviously, the downside to that is the “quite volatile” part. “Essentially a significant number of investors would recognize that this is a bubble but would be forced to participate to avoid underperforming their peers,” they go on to say. “Hence any hint of bad news would result in sharp selloffs.”
There you go.
The fun may just be getting started, especially considering the fact that the VIX has already snapped back smartly from last week.