Market surge after CPI warns skeptics it’s overdone

The colder-than-expected US inflation reading for July is a positive sign that has supported risk assets, but some investors could get a bit ahead of themselves, analysts said.

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(Bloomberg) — The cooler-than-expected US inflation reading for July is a positive sign that has buoyed risk assets, but some investors may be getting a little ahead of themselves, according to analysts.

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The rally that propelled the S&P 500 to a three-month high and the Nasdaq 100 more than 20% above its June low was fueled by bets that the Federal Reserve could become less hawkish on the bulls interest rate. Still, market watchers have warned that policymakers will want to see months of more evidence that price gains are slowing before changing their minds.

Market reaction in Asia remained positive on Thursday, with a key indicator for stocks in the region up around 0.5%. Asian emerging market currencies rose, led by the Thai baht and the South Korean won.

“The market reaction is undeniably positive, but we think it’s overdone,” said John Velis, FX and macro strategist at Bank of New York Mellon. “We still believe the Fed will raise rates by almost 4% by year-end or early 2023, and inflation, while slowing, will remain uncomfortably high.”

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Here are some comments on the future of the markets:

Base rate plateau

“The CPI release does not indicate a pivot to a dovish stance for the Fed. needed,” wrote Sarah Hewin and Steve Englander of Standard Chartered Bank in a note. “We expect that by Q4 2022 there will be enough evidence of an economic downturn to drive a 2023 key rate cuts, now taken into account, will become a key rate plateau.”

Volatility targeting

“VIX is trading below 20 for the first time since April and the VIX futures structure has steepened to the highest levels since April,” said Chris Murphy, derivatives strategist at Susquehanna International Group. “Lower levels of volatility could open the door to more stock buying from the theft targeting community.”

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Look beyond 60/40

“Are we really at the peak of inflation and the peak of Fed ferocity?” wrote Saira Malik, Chief Investment Officer at Nuveen. “While the market’s odds of a third consecutive 75 basis point rate hike at the Fed’s September meeting fell dramatically following today’s CPI release, we doubt that the Fed is deterred from continuing its already aggressive tightening path based on a single CPI report.”

Large-cap US stocks, with a penchant for high-quality growth companies, are among Malik’s favorite stocks, along with some companies and energy companies that are increasing their dividends. Investors should look beyond the traditional 60/40 fixed income equity portfolio, using real assets such as farmland as inflation hedges via predictable cash flows and built-in CPI indexes , she said.

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Australian under pressure

The Aussie dollar rose overnight after the release of CPI data, but it “will likely remain hostage to broader dollar trends and shifts in the global economic outlook,” wrote Carol Kong, strategist at the Commonwealth Bank of Australia Ltd., in a note. “Given rising global interest rates and high inflation, market participants are likely to further downgrade the global growth outlook, which is negative for the pro-cyclical AUD.”

“I think the downward pressure on the AUD will continue as I’m still of the view that the Fed will be much more aggressive on rates than the RBA will be,” said Alex Joiner, chief economist at IFM Investors Pty. I think the volatility will continue in the markets as they still struggle to assess the high inflation and deteriorating economic outlook.

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Smooth retreat unlikely

The market has gotten a bit ahead of itself in pricing for key rate spikes next year, said Stephen Miller, investment consultant at GSFM, a unit of Canada’s CI Financial Corp.

“We need to determine how sticky inflation is and whether the market’s benign view of it and the Fed ends up being accurate. Any smooth retreat towards 2% within three years still seems like a big ask,” he said.

Limit the euphoria

“While this means some relief for risky Asian assets at the margin, we believe there will potentially be more Fed hawkish speakers who will continue to drive market prices higher from the Fed tightening cycle” said Charu Chanana, strategist at Saxo Capital. Markets Pte in Singapore. “That could potentially limit the euphoria in Asia.”

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Bear Rally Peak

“The market may lack positive catalysts after today’s spotlight moment, suggesting that the current bearish rally is also heading towards its peak,” said Hebe Chen, analyst at IG Markets Ltd. Plus, once investor expectations stabilize on a 50-bps base rise next month, “the predefined playbook (i.e. 75bps) will turn out to be a nasty surprise.”

Meanwhile, traders in the Australian stock market may choose “to remain cautious going into the end of this week as we welcome our jobs data next week, which should prove that inflation will stick around for a long time to come,” he said. she declared.

(Updates with Asian market reaction to 3rd paragraph and other analyst comments)

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