Inventors anticipate another Fed pause in November

It started as a good week for equities. A drop in bond yields and a decline in the dollar supported stocks, sending the averages higher. That changed in the latter half of the week when both the ten-year and thirty-year Treasury bond auctions were trashed by buyers.

The latest inflation numbers did not help either, nor did more tension in the Middle East. Combined, these developments managed to puncture the goldilocks assumptions that had pushed markets higher over the last few days.

The bull case for stocks had its roots in the run-up in bond yields over the last few weeks. While negative for stocks initially, however, most clouds have a silver lining. In the case of rising yields, a quick back-of-the-envelope estimate by traders and pundits indicated that the climb in yields was equivalent to at least another rate hike by the Fed and maybe more.

That would mean (so the argument goes) that the Fed, in an ideal world, would not need to raise interest rates again at their next meeting in November. The market had already done that for them. And if yields, especially on the long end, continue to rise then the Fed's job of tightening could be done. Over the last week, several Fed officials intimated that could be the case.

If that scenario were to play out, then markets would have all the justification in the world to rally. While that is good news, we may be getting ahead of ourselves. One fly in the ointment could be a sticky inflation rate. This week's Producer Price Index and Consumer Price Index for September were both higher than most economists had expected. Granted, not by much, but the data continued the trend established in August of hotter numbers overall.

Right now, the markets are attempting to look through those numbers because most of the back-up in inflation was thought to be caused by the rapid spike in oil prices during the last month.  Since then, oil has come down in price somewhat but not by much thanks to the turmoil in the Middle East. It is anyone's guess where the commodity will trade from here. Aside from the influence of the Israeli/Hamas war, some analysts are predicting a return to $100/bbl. or more, while others think oil could decline further.

Any predictions on oil prices depend on the present geopolitical events as well as how the world economies will fare into next year. Strong growth will support prices, especially with the present ongoing production cuts in place by OPEC+. A lot may depend on whether China's economy climbs out of the doldrums, or simply bumps along at its present rate. The point is that oil remains a wild card in determining whether inflation will decline, remain at present levels, or climb.

The geopolitical events of last weekend continue to reverberate throughout the world. Some traders were expecting a much higher spike in oil prices following the Hamas massacre in Israel. For that to happen, in my opinion, the conflict would need to widen, embroiling Iran and possibly other nations into the conflict. That has not occurred, yet, but it could.

Another sticky variable besides inflation is the level of jobs in the U.S. economy. There is still no sign that the central bank's year-plus tightening of interest rates has had any appreciable impact on U.S. employment. U.S. jobless claims were unchanged again this week at 209,000, which is close to a seven-month low of 202,000 made in September.

We also can't forget the difficult situation in Washington. The Israeli conflict in Gaza and its expected escalation, and the hostilities in Ukraine underscore the need for a U.S. response. And that is only on the international front. Here at home, the problems are mounting as well. Yet the nightmare that has become the Republican party continues to run amuck. It seems ever clear to the nation that the GOP has lost its ability to govern, at least in the House of Representatives. This failure goes far beyond the prospect of a government shutdown and could begin to impact financial markets unless something changes and quickly.

Last week, I advised investors that we are in a bottoming process. The recent rally has already retraced 50% of the entire nine-week decline in just five trading days. We see this often when sellers are exhausted, and an army of dip buyers rush into stocks all at once. I expect more back-and-fill here next week as third-quarter earnings begin in earnest.

It is hard to tell whether we can confine the downside down to the lower 4,300s from here on the S&P 500 or re-test the recent lows around 4,200. I think events in the Middle East will dictate the level of consolidation before we once again move higher. My intermediate target on the S&P 500 is somewhere in and around 4,520 or so.

Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires.  Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI).  None of his commentary is or should be considered investment advice.  Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at bill@schmicksretiredinvestor.com .Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.