Oil stays hot, yields kiss 5%, AI gets tested — Fed decision looms

Well, Friday gave investors a reason to breathe — but I’m not sure it gave them a reason to relax. In the end – we have to ask – was the move the beginning of something bigger or was it just a ‘dead cat bounce’?

After four straight days of losses, buyers finally showed up and took stocks higher. The Dow gained 1%, the S&P added 0.9%, the Nasdaq rose 1% and the Russell gained 0.4%, the Transports added 0.3%, the Equal Weight up 0.8% and the Mag 7 gained 1%.

Of the 11 sectors - Tech gained 1.3%, Industrials +1.1%, Communications gained 1%, Consumer Discretionary added 0.9%, while Real Estate added 0.8%.

Utilities lost 0.3% while Healthcare gave up 0.2%. Down the chain we saw strength in Homebuilders +1.6%, Retailers +1.4%, Airlines up 1.2%, disruptive tech +0.6%, EEM +1.2% and in an interesting twist - the value trade and the growth trade were neck and neck at +0.8% while Semi’s added 1.8% and Memory names (DRAM) added 1%

Why?

Well, there were a couple of reasons. First and foremost - Friday’s rally wasn’t necessarily about buyers suddenly becoming wildly bullish. It was about sellers becoming exhausted.

After four straight days of pressure, anyone who wanted out had been given plenty of opportunity to get out. At some point the selling gets exhausted.

Then oil backed off. WTI fell $2.43 to settle at $100.05 while Brent ended the day at $104.61 and that gave traders and algo’s a reason to step back in. Which is a bit of a riddle, because the buyers were always there, they were just buying stocks cheaper, because the sellers were being more aggressive. On Friday, when the sell pressure eased, buyers had to reach for stock causing prices to move up.

Understand this - While oil backed off on Friday, the inflation story did NOT. Oil, Diesel & Inflation remain front and center. Let’s not lose perspective.

WTI is still sitting at $100. Brent is still north of $104, and diesel pierced $6/gallon and that is the key to all of this….and you should be surprised – we discussed last week….

Diesel moves the trucks, food, construction equipment, farm equipment, and manufactured goods. It essentially moves the world. So, ultimately higher diesel costs work their way through the system (eventually) and show up in the price of just about everything.

Which brings us to Friday’s CPI. (Consumer Price Index).

Headline CPI rose 0.4% m/m and 3.4% y/y, while core prices rose 0.3% m/m and 2.4% y/y on the month – unchanged over last month so it was actually well behaved, no upside surprise, which suggests right now – the pressure we are seeing is coming from the energy space.

Gasoline jumped 3.9% in August and is now up more than 27% from a year ago. So, while the CPI wasn’t some runaway disaster, some believe that it was not the report the Fed needed if they were looking for an excuse to comfortably remain on the sidelines. And we saw that in the expectations…. The probability of a 25-basis-point hike this Wednesday surged after the report – rising to 87% by Friday afternoon — up from 72% on Thursday and near 50% two weeks ago.

Translation? The market believes a September rate hike is essentially locked and loaded. But here’s where I think it gets interesting and why I am asking - Does the Fed Really Need to Hike?

Everyone is focused on what Kevy and the FOMC are going to do on Wednesday. I say, why do anything – the bond market has already done most of the work for them. The 10-yr Treasury is kissing 5% this morning. The 30-yr is yielding 5.34%. 30 yr mortgage rates are rubbing up against 7%; corporate borrowing costs are higher. Financial conditions have tightened — WITHOUT the Fed doing a damn thing.

So, let’s discuss. There are really four possible outcomes investors need to consider — because the Fed makes the first move, but the bond market gets the final word.

Scenario 1 — The Fed HIKES and the 10-year FALLS. That’s probably the cleanest outcome. The bond market is essentially saying: OK — we believe you. The Fed demonstrates that it’s serious about inflation, longer-term inflation expectations settle down, the 10-year backs off, and stocks probably breathe a sigh of relief.

Scenario 2 — The Fed HIKES and the 10-year RISES. Now we’ve got a problem. The Fed is tightening at the short end while the bond market continues tightening at the long end. That’s tightening on top of tightening. If the 10-year breaks through 5% and keeps going, the bond market is telling us that the problem is bigger than monetary policy alone.

Mortgage rates go even higher. Corporate borrowing costs are higher. The cost of capital goes higher, and equity multiples come under pressure.

Scenario 3 — The Fed HOLDS and the 10-year FALLS. Now the bond market is essentially saying: You were right not to hike. Financial conditions are already tight enough. And frankly, this is the scenario that would support the argument I’ve been making. The bond market has already done much of the tightening for the Fed. If Warsh holds and longer-term yields decline, then perhaps the market agrees that another 25 basis points simply wasn’t necessary. Stocks would probably like that combination.

Scenario 4 — The Fed HOLDS and the 10-year RISES. This could be the most dangerous outcome. The initial equity reaction might be: No hike! Great! But be careful what you wish for…. If the Fed holds and the 10-year blows through 5%, then the bond market will be sending a very different message: We don’t believe you’re serious enough about inflation and now you have a credibility problem.

This is when inflation expectations could become unanchored, causing investors to demand an even higher yield - the long end tightens more – the only thing is the Fed is NOT in control. That’s why I’m interested in what happens afterwards.

And Then Came the Weekend…

Just as the markets celebrated Friday’s decline in oil, Middle East risk came roaring right back. Saudi energy infrastructure came under attack again over the weekend, putting the risk to Gulf energy supplies right back on the front burner. So don’t make the mistake of thinking Friday’s decline means the oil story is over. It’s not.

This morning - WTI is trading up $3.15 or 3.2% at $103.25, effectively erasing Friday relief rally reminding us that the geopolitical risk premium remains very much alive.

Then we got an unexpected headline. Remember this name – Jacob Coxon.

Last week, Jacob Coxon - a researcher who spent the past three years working on pre-training at both OpenAI and Anthropic - resigned from Anthropic and sounded the alarm over where this AI race is headed.

Coxon argued that the major labs are racing toward self-improving superintelligence without having solved the safety problem - warning that the competition to get there first is forcing everyone to move faster than perhaps they should.

Then over the weekend, the story got louder. Anthropic CEO Dario Amodei called for additional safeguards and a slower pace of development of the industry’s most advanced models. Sam Altman backed the idea. Elon Musk agreed and now every democrat is backing the idea.

Now, I’m not going to debate whether AI is going to save humanity or destroy it – that’s for someone else - but from an investor’s perspective, you can bet that investors, traders and algo’s are going to test the AI trade and in fact – they are already doing it.

Overnight Asian AI names got hammered overnight: SoftBank -11%, SK Hynix −6.4%, Samsung −4.1% and TSMC −1.2%. European tech is also down this morning about 1.4%, with Infineon −5.8%, ASMI −5% and ASML −4.4%.

And here at home – the semi’s are getting sold in the pre-mkt – NVDA -2.8%, AMD -5.2%, AVGO -3.2% and MRVL – 6.8%— along with some of the higher-beta AI infrastructure names like CRWV -6.6%, ANET -5% and VRT -6%.

And then you’ve got the premium-multiple AI software names that will most likely get hit - because when you have a stock with a premium multiple, you don’t need the earnings story to change to knock the stock down, sometimes all you need is for the narrative to change.

But has the AI narrative actually changed? I don’t think it has - at least not yet. Don’t confuse slowing AI model development with slowing AI infrastructure spending. Those are two very different things. Remember MSFT, AMZN, META and GOOG still need data centers. They still need chips, servers, networking, cooling — and they need power.

So, while NVDA, AMD, AVGO, MRVL, CRWV, ANET & VRT are getting caught up in a knee-jerk AI selloff, I’d be careful about confusing a trade with a change in the long-term thesis.

There is no Eco data today. Tomorrow brings us the Empire Manufacturing Survey. Wednesday is about Retail Sales – and they are expected to rise by 0.8%. Now with gas surging – will the consumer start to buckle? Thursday brings us Housing Starts; Building Permits and Pending Home Sales. Friday ends with Industrial Production and Capacity Utilization.

European markets are mostly lower. Italy and the Euro Stoxx both down 1%, France and Spain lower by 0.8%, Germany down 0.7% while the UK is up 0.5%. As noted, Tech is getting sold hard.

US futures at 5:30 am are lower as well with the pressure focused on Tech. Dow – 150 pts, the S&P’s down 60 pts, the Nasdaq is getting punched in the face down 550 pts or nearly 2% while the Russel is down 10.

The S&P closed at 7,656 — up 65 points — just on the north side of the trendline, which puts us right back in that 7,600/7,790 trading range. The pressure this morning is about to test that trendline, if 7,600 holds, then the bulls remain in the game, and 7,790 will be the level they need to challenge on the upside.

If we break 7,600 then suddenly Friday’s rally starts to look more like a ‘dead cat bounce’ rather than the beginning of a new move higher.

Chicken scarpiello with hot cherry peppers

Just like this market, Scarpariello is all about heat, pressure and balance. You've got hot cherry peppers — that's oil. You've got the sausage and garlic bubbling away in the pan — that's the bond market, keeping the pressure on. And then you've got the spice — that's AI. Exciting, powerful, maybe even a little dangerous…and right now nobody seems quite sure how hot it's going to get.

And standing over the whole thing is Kevin Warsh and the Fed — trying to decide whether to turn the flame UP another notch or leave it alone and let everything already in the pan do the work.

Because here's the thing about Scarpariello - You don't fix a pan that's already too hot by automatically turning up the flame. Sometimes you let it cook. Sometimes you add a little wine. Sometimes you back off and let all those competing flavors settle down and come together. Which sounds an awful lot like the decision facing the Fed on Wednesday.

Prep time: 30 m

Cook time: 1h

Total time: 1h 30m

Serves: 4-6

Ingredients

8 bone-in, skin-on chicken thighs

1 lb sweet Italian sausage

1 lb baby potatoes, halved

6 cloves of garlic

1/2 c hot cherry peppers, sliced

1/2 c Sweet cherry peppers, sliced

1/2 c dry white wine

1 c chicken stock

2 tbpn red wine vinegar, butter, fresh rosemary, and parsley, olive oil, s&p

Preparation

Step 1

Heat your oven to 400°F.

Step 2

Toss the potatoes with olive oil, salt and pepper and roast until golden and crispy — about 30 minutes.

Step 3

Season the chicken aggressively with s&p.

Step 4

Get a large cast-iron skillet screaming hot, add a little olive oil and place the chicken skin-side down. Leave it alone. Let that skin get dark, golden and crispy before turning it over. Remove and set aside.

Step 5

Now brown the sausage in the same pan. Once it develops some color, add the garlic and rosemary.

Step 6

Add as many hot cherry peppers as you think you can handle — because just like oil at $103, once you put the heat in, you can't pretend it isn't there.

Step 7

Deglaze with the white wine, scraping all that goodness from the bottom of the pan. Let the wine reduce, then add the chicken stock and red-wine vinegar.

Step 8

Return the chicken to the skillet, skin-side up, add the sausage and transfer the whole thing to the oven for about 20–25 minutes, until the chicken is cooked through.

Step 9

Pull it out, swirl in the butter and add the roasted potatoes. Finish with fresh parsley and spoon that spicy, sweet, tangy sauce over everything.