Inflation and the S&P 500

Still in danger

The S&P 500 bounced yesterday, adding to the solid gains made on Friday. The rally has seen the index push back up above resistance around the 2,600 area and this has complicated the technical picture to some extent. If it had closed below here then the likelihood was that the next move would have been to the downside. But Friday’s bounce has given dip buyers the confidence to re-enter the market with stops around 2,600.

The S&P 500 is once again closing in 2,655 which marks the 100-day simple moving average (SMA). But US equities aren’t out of danger yet. The index is trading between resistance at 2,700 and support (previously resistance) around 2,600. A break to the upside (which would first have to clear the 100-day SMA) would indicate that the correction is over. A break below 2,600 would suggest that there’s a bigger shakeout coming with a retest of the 200-day SMA around 2,560 being the first major downside target.

CPI in focus

Now it’s possible that we’ll get a resolution to this at some stage this week. However, it may not be until after we see the January update for US CPI on Wednesday. It was the fear of a pick-up in inflation that drove up US Treasury yields which in turn helped trigger Wall Street’s sell-off. Just over a week ago Average Hourly Earnings came in way above expectations, sparking concerns that higher wage growth would force the Federal Reserve to raise rates by 100 basis points this year, rather than the 75 basis points previously anticipated. Now all eyes are on the January CPI release.

Headline CPI (including food and energy) came in at +2.2% in November but slipped back to 2.1% in December. Investors are hoping for further evidence that inflation has topped out for now. If so, and we see another modest reduction to 2.0% then this should be enough to push bond yields down and equities up. But in the current environment we can expect US Treasury yields to soar if January’s number were to come in at 2.1% or higher. This would be a problem as the key 10-year Treasury note yield is dangerously close to testing 3.0% - a four-year high, increasing fears that the 35-year bond bull market is finally over. This would signal higher borrowing costs to come which would not be good for global equities.