October 17, 2022

Market Update


Conventional wisdom is that when the Fed wins its fight with inflation, stocks will take off. But if inflation slows and wage inflation is sticky, margins will contract. Early in the cycle, inflation helps companies. Later on, it hurts margins.

Analysts expect Q3 EPS of $55.67, up 2.6% YoY. Excluding energy companies, earnings would contract 3.9%. As economy slows, higher unemployment will hurt consumer demand. The ISM Manufacturing Index indicates that we may also have to worry about that sector.

The CPI Report

Sticky inflation rose at more than an 8% annualized rate last month. Goods inflation was unchanged MoM, and the trimmed mean and median CPI measures were at all-time highs (since 1984).

The Market’s Response

The Tick index, which measures the number of equities rising vs. falling hit - 1,900 and then +1,900. There has never been such an extreme swing. Tremendous put-buying was reported in anticipation of the CPI release. Market makers (selling puts) hedge by shorting stock. When the market dropped the puts were unwound and the VIX actually dropped. Market makers closed out their short positions (hedges) by buying stock.


  • The market may look through a disappointing CPI report, but it will be a much higher bar to look through weak corporate earnings
  • Betting on a pivot makes one less likely. It eases financial conditions while the Fed is trying to tighten conditions.

Bonds and Interest Rates

Treasury liquidity is evaporating and volatility is soaring. Even demand in government debt auctions is becoming a concern. The bid-to-cover ratio for Wednesday’s 10-year auction was one standard deviation below the one-year average.

The biggest players in the $23.7T UST market are in retreat – from Japanese pensions and life insurers to foreign governments and US commercial banks. In addition, the Fed is doing $60B of QT each month.


  • Investors are worried about volatility, deteriorating liquidity and weak auctions. Steep hedging costs have restricted Japanese investment.
  • Central bank currency intervention could result in selling USTs.
  • The balance sheet capacity of broker-dealers to engage in Treasury market- making has not expanded at the same rate as the supply of Treasuries. Janet Yellen said that “we are worried about a loss of adequate liquidity in the [Treasury] market.”

The Fed

As central banks push rates into restrictive territory, this is when markets start to fear overdoing it. It’s one thing to say that unemployment needs to go higher, it’s another thing to raise rates while it’s happening.

The Federal Reserve is posting its first operating loss in years as interest rates increase. Remittances to the U.S. Treasury are -$2.9B. The Fed can’t go bankrupt and this simply means that the Fed is remitting less money to the Treasury. The Fed’s interest expense (IOR and RRP counterparties) increases with each rate hike. In the years since the global financial crisis, the Fed remitted more than $1T to the U.S. Treasury.


  • The market is now expecting the Fed funds terminal rate to reach 4.965%. For much of the year, inflation expectations moderated. The result is that real rates are rising.
  • Many participants emphasized that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action.