The inflation reading turned out to be much higher than expected. In response, equity indices first dived as expectations of future interest rates rose. However, soon afterwards, they shot up. Investors seem to be wondering what could be behind the biggest daily reversal in stocks since 2020.
Inflation reading higher than expected
CPI inflation rose by 0.4% last month, up 20 bps (basis points) more than the average expectation (0.2%). Consequently, September inflation was 8.2% year-on-year. This is 10 bps lower than the previous month, but also 10 bps above average expectations. Most sources seem to agree on a pessimistic interpretation of the data for share prices due to the increasing likelihood of a large US interest rate hike. Core inflation also rose to 6.6%, the highest level since 1982.
SPY, hourly candles
Source: Conotoxia MT5
Market turns around despite pessimistic data
As soon as the reading was released, the markets plunged. The SPY (S&P 500) and QQQ (Nasdaq Composite) ETFs were down 2.1 and 2.9%, respectively, at the market open. Initially, the indices fell further and posted daily losses of 2.5 and 3.3% at the bottom, but immediately afterwards the situation began to reverse. From this level, the indices made a massive move of 5.2 and 5.8% from the daily low. The session ended with a 2.6 and 2.4% positive daily price change.
What could have led to such an unusual turnaround in the market?
Economists working for the ECB (European Central Bank) yesterday put forward a maximum level for interest rates of 2.25%, which would allow inflation to reach the 2% target. According to Reuters, this is much lower than analysts who predicted a rise to 3% just two weeks ago, to fight inflation. The over-indebted countries of southern Europe may be tying their hands for eurozone monetary policy. A significant increase in interest rates, would raise the cost of debt servicing in these countries and could expose them to gigantic budget expenditures.
The second important factor seems to have been the relatively good first-quarter earnings of companies in the US. This could have improved investors' expectations of the market, at least in the short term. Yesterday, US bank stocks also saw powerful gains (around 5%) ahead of today's quarterly results from Citigroup, Wells Fargo and JP Morgan, following an optimistic statement from the latter's CEO.
The financial sector has been plagued by several problems in recent times, affecting European banks in particular (Credit Suisse, UBS, Deutsche Bank). The risk of transferring the problems of one institution to another seemed to be factored into their share prices. Hence, the strong reaction to the CEO's words about the large reserves of one of the leaders may have calmed investors.
The UK government with new Prime Minister Liz Truss yesterday confirmed a plan to cut taxes and maintain current levels of government spending. Finance Minister Kwasi Kwarteg announced £50bn in tax cuts and unprecedented support in payments for record-high electricity charges, without specifying how such help would be provided.
The exact reason for the sudden market reversal is unknown, but it seems that a lot of presumably positive news for the market came together almost at once. In addition to those mentioned above, there were also mentions of alleged peace negotiations between Ukraine and Russia. So far, these reports have not been confirmed. Bloomberg News additionally provides other possible reasons, such as a rebound from price support levels or bears taking profits.
What will the Fed do?
The key question continues to be what the FED will do. According to CME Group data, the current probability of a 75bp interest rate hike in the US is as high as 95%, having risen by almost 11 percentage points over yesterday's session and by more than 14 percentage points over the week.
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Rafał Tworkowski, Junior Market Analyst, Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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