Wall Street takes risk off table before CPI report

A rout in technology companies dragged down the stock market, with investors gearing up for a key inflation report that’s expected to bring more insights on the outlook for the Federal Reserve’s next steps.

The Nasdaq 100 underperformed, falling 1.1%. Apple, which unveiled the iPhone 15 and other products, dropped almost 2%.

Its launches are famous “sell-the-news” events. Oracle sank the most since 2002 after a slowdown in cloud sales. U.S.-traded BP shares slid as its chief resigned at a time when the company is trying to persuade investors to stick with it through a costly transition to low-carbon energy.

A rally in crude sent energy shares higher and added to concern about inflationary pressures. Banks also gained amid a presentation at the Barclays Global Financial Services Conference.

Treasury two-year yields, which are more sensitive to imminent Fed moves, topped 5%.

The auction of 10-year U.S. Treasury notes on Tuesday drew the highest yield since 2007 – a day after a sale of three-year notes did the same – as investors demand increased compensation for elevated inflation and growth in the supply of U.S. government debt.

The dollar edged higher.

Wednesday’s consumer price index is expected to show a pickup in inflation pressures.

With the economy defying pessimism and energy prices rising, analysts predict the biggest monthly jump in 14 months– and the swap market is pricing in risk that it will come in even higher than expected.

Traders expect the Fed to stay on hold at a policy meeting next week, and see roughly a 50% chance that it delivers a hike in November.

“In our view, it may be a good moment for investors to consider allocation moves that prepare for a re-firming of inflation this fall,” said Lauren Goodwin, economist and portfolio strategist at New York Life Investments.

“For example, cyclical growth equity sectors soared on hopes of a divine disinflation and near-term Fed cuts. Yet, if inflation re-emerges, these sectors might give up some of their year-to-date gains.”

The Cleveland Fed’s Nowcast model suggests upside risks for CPI, with persistently high inflation seen in September as well, according to Win Thin, global head of currency strategy at Brown Brothers Harriman.

“With inflation data expected to show ongoing stickiness, we think it’s risky to go into tomorrow’s CPI report short dollars,” Thin noted.

CPI is really key because if it halts its downward trend, markets will have to price in a more hawkish Fed – and that would be a head wind on stocks, said Tom Essaye, a former Merrill Lynch trader who founded The Sevens Report newsletter.

“Put in a more familiar way, CPI impacts two of the three pillars of the rally: disinflation and expectation the Fed is done with rate hikes,” Essaye noted. “If CPI is too hot, both will be damaged.”

Traders continued watching closely the negotiations between the United Auto Workers and automakers to prevent a strike.

General Motors, Ford and Stellantis are under pressure to meet the demands of the UAW, which is seeking a new contract that replaces one expiring in just two days.

A strike, even a short one, would ripple across the U.S. economy. That includes possibly pushing Michigan into a brief recession.

There’s been a “dramatic shift” in investors’ equity allocation – a rush toward the U.S. and an exodus from emerging markets, Bank of America’s latest global fund manager survey showed.

That’s had an impact on emerging markets equity allocation, which fell to a net 9% overweight in September from 34%, the lowest reading since November 2022.

In contrast, allocation to U.S. equities rose 29 percentage points to a net 7% overweight – the first overweight reading since August last year, according to the survey.

To Dan Wantrobski at Janney Montgomery Scott, the market continues to carve out a “rangebound glide path” near term, and this should possibly continue being the case as we move through September and into the final quarter of 2023.

“Overall, we believe elevated volatility will surface again, but stocks may still see more rally efforts over the short-run – making for a very choppy trading range.”