The recent pullback in the S&P 500 has primarily been driven by the yield curve bear flattening, which means the short end has repriced significantly more than the long end has priced in additional nominal GDP. In simple terms, this is the Fed playing catch-up after its previous inaction during the inflationary shock and the rise in growth expectations. If you have been following the research pieces I have been putting out, then you know that over the last month I have been bearish bonds and neutral equities (link). This has proved to be very beneficial because we hit 7600 in a capitulatory move in ES last week during FOMC, when the forward curve priced in MORE hikes as the Fed caught up in its stance relative to growth and inflation.
What is critical to understand is that the Fed drives the short end, but the long end is driven by the Fed + nominal GDP. People like to call the premium between short-end and long-end rates many different things: duration risk premia, term premia, long-term nominal GDP expectations, inflation risk premia, etc. At the end of the day, this is about how much of the movement in long-term rates can be explained by the actions of the Fed in the short end. Any residual is what we are trying to predict and derive a signal from in order to have a clearer view of WHAT is taking place and WHY it is happening. The chart below shows HOW MUCH of 30-year yields is driven by the Fed’s control of the short end (orange bars) vs term premia/long-term nominal GDP. You can see the chart over the last 2 years here:
What I want you to zoom in on is the misunderstood shift that is taking place right now. If you understand this shift, you will understand WHY equities bounced back from the 7600 level and WHERE they are likely to move from here.
