Is the Stock Market Really Done Falling? Don't Get Your Hopes Up

Markets roared back as Fed rate-hike bets cooled — but they may be falling for the wrong reason. Is the relief rally misreading demand destruction as good news?

• Stocks, gold, and bonds all rebounded sharply, though the move looks more like a retest than a confirmed reversal
• Odds of a December Fed rate hike slid from near-certain on Monday to roughly 60/40 today
• But softer core inflation looks like demand destruction — the consumer breaking, not prices cooling

Markets recovered aggressively across the board on Thursday after a brutal cash-for-everything liquidation earlier in the week. Stocks bounced, gold staged a violent reversal, and bonds rallied. The question is whether the story has actually changed or whether this is a reflexive bounce inside a larger breakdown. The early read leans toward the latter.

A retest, not yet a reversal

The bellwether S&P 500 came roaring back toward the range it shattered just a day before. The index is grinding right where it paused before the breakdown — a retest of whether the market truly wants to extend lower rather than proof that it does not.

Gold’s turn was more violent, erasing nearly all of the prior session’s plunge, yet the larger breakdown remains intact. The bounce may still turn out to be no more than a temporary retracement.

Tellingly, crude oil barely budged even as the White House canceled threatened strikes on Iran in exchange for a supposedly imminent signing of a memorandum of understanding (MOU) — a deal to begin talks, and not a peace accord. For now, the war-trade premium in oil is not unwinding in earnest.

The rally is really a bet on cheaper money

The common thread is bonds. With stocks and gold rebounding, Treasury bond prices rallied too, pushing yields lower in what amounts to an unclenching of interest-rate fears. The odds of a December rate hike from the Federal Reserve, priced as all but certain on Monday, fell to roughly 60/40 by today. 

Besides hopes for a US-Iran breakthrough, May’s US PPI data might have helped. While energy prices buoyed the headline reading, core wholesale prices rose a softer 0.4% on the month versus 0.5% expected. The year-on-year trend PPI growth rate held at 4.9%, rather than climbing to 5.4% as economists feared.

The catch: softer prices look like demand destruction

However, a look inside the PPI report’s internals suggests these seemingly benign results appeared not because inflationary pressure faded, but because the consumer is buckling under it. Margins were squeezed hardest are on automobiles and auto parts, while the fattest ones still belong to sellers of fuels and lubricants. Wholesalers slashed their cut on big-ticket, energy-dependent goods to protect demand, in a sign that it may be evaporating. 

Consumer price index (CPI) data published earlier in the week told the same story: core goods prices fell, but the driver was a decline in used cars and trucks. That looks like demand destruction in plain sight. Energy is squeezing spending on the expensive, fuel-hungry things consumers can no longer justify.

Meanwhile the spillover the Fed actually fears is still building. Core services inflation crept back above 2% for the first time since January, led by transportation and warehousing — the sector’s energy-sensitive corner — for a second straight month. Services prices drive the bulk of inflation, and price rises here looked sticky even as the goods prices rolled over for the wrong reasons.

That is the worst of both worlds for the US central bank. Sticky underlying inflation alongside a consumer that is already pulling back put its policy objectives on a collision course, making it devilishly hard to craft a response.

The wrong kind of rate relief

This is why falling rate-hike odds may be nothing to celebrate. If the Fed ends up holding or easing because demand is collapsing, that is a recession signal, not a green light for risk assets that depend on consumers spending.

Bond market breakeven inflation rates — the 5-year and 10-year expectations embedded in Treasury pricing — have begun diverging lower from crude oil, which itself refuses to break. The market seems to be looking downwind of the price spike and pricing damage to growth, not relief from it.

The fragile shape of US growth is what makes this dangerous. First-quarter gross domestic product (GDP) expanded largely because business investment — about 14% of the economy — grew at better than a 10% annualized clip and out-contributed consumption, which is 68% of output and has now retrenched for a second straight quarter. The data center builders driving that investment face the very same energy and freight costs crushing the consumer; they are not immune.

It would not take much further weakening in the dominant 68% slice of the economy to overwhelm even a fast-spinning investment engine. Tomorrow’s University of Michigan consumer sentiment reading — already at a record low of 44.8 — will offer the next read on how close that breaking point is. What looks like a turnaround may instead be a handoff: stocks left hampered while bonds stop falling, as the market trades one fear – inflation – for a graver one: recession.

Ilya Spivak, tastylive Head of Global Macro, has over 15 years of experience in trading strategy. He specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

For live daily programming, market news and commentary, visit tastylive.com or @tastyliveshow on YouTube

Trade with a better broker, open a tastytrade account today. tastylive, Inc. and tastytrade, Inc. are separate but affiliated companies.