Nothing to fear ... but the Fed itself

NOTHING TO FEAR ... BUT THE FED ITSELF (1620 EDT/2020 GMT)

Things could be worse. Stocks settled below the S&P 500's important 3,900 pivot level, but partly recovered from early two-month lows. A purgative wipeout has been put off again, perhaps until Wednesday, when we see whether the Fed chooses the aggressive 75 basis point hike — the odds-on favorite — the extreme 100 bp option, or the merely hawkish 50 bp.

The Nasdaq and S&P 500 suffered their biggest Friday-to-Friday drops since June.

Recession anxiety seemed to boil over in the wake of FedEx Corp's FDX withdrawal of its earnings forecast late Thursday, citing dampening global demand. That helped knock Treasury yields down a bit, so at least the market reverted to a traditional risk-off pattern.

The CBOE Market Volatility Index VIX rose to a two-month high, but stayed under 30, still not showing the usual signs of capitulation to clear the decks for buying.

Goldman Sachs noted that about $3.2 trillion of options were set to expire, including $509 billion of single stock options.

The S&P 500 ended the week down 4.8%, more than the index's 1.8% average fall in options expiration weeks, according to a Reuters analysis, and compared with an average weekly gain of 0.09% in non-expiration weeks.

Here is the closing snapshot:

(Alden Bentley)

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AMID U.S. EQUITY TURMOIL, INVESTMENT GRADE CREDIT IS RARE BRIGHT SPOT (1400 EDT/1800 GMT)

The sell-off on Wall Street has not undermined the surprisingly resilient U.S. investment grade credit market.

Goldman Sachs analysts led by chief credit strategist Lotfi Karoui say the sector's resilience speaks to the strength of the technical backdrop and the attractiveness of low-dollar price bonds for all-in yield buyers.

Late on Thursday, the U.S. investment grade's yield-to-worst (.MERC0A0), or the lowest possible yield for purchasing a bond aside from the company defaulting, was at 5.15%, the highest since September 2009.

In addition, Goldman says almost 20% of index-eligible bonds now trade below $80, "a particularly attractive backdrop for all-in yield buyers who manage risk-based capital portfolios given the overall quality of these issuers."

From a relative value and cross-asset perspective, Goldman says it continues to see the U.S. investment grade market as an attractive risk-reward proposition.

High-grade spreads to Treasuries have narrowed to 145 basis points (bps), from a roughly two-year high of 165 bps in early July, as the market remains solid despite sharp selloffs in U.S. equities.

Looking beyond the positive outlook, however, Goldman cites one major challenge. It says the aggregate cash flow usage in the first half of the year shows a clear shift away from debt repayment to buybacks and dividends. This leaves the outlook for balance sheet leverage vulnerable to a slowdown in earnings growth, the bank adds.

(Gertrude Chavez-Dreyfuss)

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BULLS REBOUND, BEARS DECLINE IN LATEST WEEK - AAII (1300 EDT/1700 GMT)

Individual investor optimism over the short-term direction of the U.S. stock market rose in the latest American Association of Individual Investors (AAII) Sentiment Survey. With this, pessimism also fell.

Investors might want to be cautious of this week's results, however, as around three-quarters of responses to the latest survey were recorded before stocks dropped sharply on Tuesday.

AAII reported that bullish sentiment, or expectations that stock prices will rise over the next six months, rebounded by 8.1 percentage points to 26.1%. That said, optimism remained at an "unusually low" level for the third consecutive week. It also keeps bullish sentiment below its historical average of 38.0% for the 43rd-straight week.

Bearish sentiment, or expectations that stock prices will fall over the next six months, declined by 7.3 percentage points to 46.0%. Bearish sentiment is above its historical average of 30.5% for the 42nd time out of the past 43 weeks and is at an "unusually high level for the 27th time out of the last 35 weeks." AAII says that the breakpoint between typical and unusually high readings is currently 40.5%.

Neutral sentiment, or expectations that stock prices will stay essentially unchanged over the next six months, dipped 0.8 percentage points to 27.9%. Neutral sentiment is below its historical average of 31.5% for the 19th time in 21 weeks.

With these changes, the bull-bear spread was last at -19.9% and is "unusually low for the 28th time in 34 weeks." AAII says that the breakpoint between typical and unusually low spread readings is now –10.9%.

AAII added that "historically, the S&P 500 index has gone on to realize above-average and above-median returns during the six- and 12-month periods following unusually low readings for bullish sentiment and the bull-bear spread."

(Karen Brettell)

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WINTER IS COMING (1209 EDT/1609 GMT)

Energy prices have soared this year, with no continent hit worse than Europe, according to Wells Fargo strategists. Things only got worse after Russia abruptly stopped supplying gas to the region through a major natural gas pipeline, with worries now emerging of a frosty winter.

Needless to say, natural gas prices in Europe have also spiked recently, which Wells Fargo says isn't as big a problem as the continent's dependence on Russian gas.

Now heading into winter amid high gas prices and low imports, Europe is staring at a full-blown energy crisis.

Wells Fargo says Germany and the rest of the European Union may not need to ration gas usage extensively but it all comes down to how cold the weather is. The real question is whether this could have a potential impact on the United States and the rest of the world.

In some ways it already has in Asia, that relies heavily on natural gas imports, now competing with Europe amid short supplies. But the United States is the largest producer of petroleum and did benefit from some exports to Europe, Wells Fargo notes.

The U.S. has a comparatively low dependence on energy imports, hence, the energy crisis in Europe has only highlighted some of its pre-existing advantages in this space.

(Shreyashi Sanyal)

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UMICH LIGHTENS THE MOOD: CONSUMER GLOOM WANES (1115 EDT/1515 GMT)

The mood of the American consumer grew slightly less cloudy in September.

Woo-hoo!

The University of Michigan's preliminary take on current-month Consumer Sentiment (USUMSP=ECI) edged up 1.3 points to 59.5, narrowly missing the 60 consensus.

The expectations component's gain surprised to the upside, while assessment of current conditions notched a more modest gain.

Still, even as the consumer's smile widened, their worry lines deepend.

"After the marked improvement in sentiment in August, consumers showed signs of uncertainty over the trajectory of the economy," writes Joanne Hsa, director of UMich's Surveys of Consumers.

Here's a look at the U.S. consumer's take on now versus the future; UMich "current conditions" and "expectations" components. Tellingly, the expectations reading is higher than the current conditions component for the first time since 2009, when the economy was digging itself out from the wreckage of the Great Recession:

The 5-year inflation expectations component eased to 2.8%, the lowest reading since April 2021. And 1-year inflation expectations posted a welcome cool-down to 4.6%.

Which begs the question: how accurate are UMich inflation expectations? While no one has a crystal ball, the answer is "it depends."

The graphic below offsets one-year inflation expectations by shifting it one year to the right, offering a visual comparison to consumer predictions to the cold current reality of headline CPI.

Perhaps unsurprisingly, they're fairly well in-sync when economic uncertainties are elevated:

Finally, despite the current-month uptick, the consumer mood remains darker than it was in the immediate aftermath of the pandemic shutdowns which brought the global economy to its knees.

"Generally, the sentiment data has been sliding sideways as consumers try to reconcile strong economic and labor market conditions against expectations of a recession," says Jefferies economists Thomas Simons and Aneta Markowska.

A healthy reminder: what consumers say and what they do are often two very different things.

Remember, August retail sales unexpectedly rose. And while worries persist, the consumer - who contributes about 70% to U.S. GDP - continues to spend, particularly on services.

Generally, the sentiment data has been sliding sideways as consumers try to reconcile strong economic and labor market conditions against expectations of a recession.

Here we see a comparison of monthly point change in the UMich sentiment topline with the monthly percent change of the consumer outlays segment of PCE:

Wall Street was extending Thursday's sell-off, with the S&P 500 dipping below the closely-watched 3,900 support level and all three major U.S. stock indexes setting themselves up for their biggest one-week percentage losses in months.

(Stephen Culp, Vincent Flasseur)

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WALL STREET SHARES FALL IN EARLY TRADE (1007 EDT/1407 GMT)

Shares on Wall Street are on the defensive once again on Friday amid a profit warning from Fedex, adding to worries about Federal Reserve rate hikes, inflation, and the risk of recession.

The U.S. stock indexes hit two-month lows earlier, with the Dow Jones Transport Average Index DJT down 6% and earlier falling to a 1-1/2 year low.

Fedex FDX is down 23%, the largest decliner on the S&P 500. Rival UPS UPS is also down 5.5% and so is XPO Logistics XPO, falling 7.3%. Amazon AMZN has also been affected, with shares down 4%.

Meanwhile, the Fed is expected to deliver another 75 basis-point hike next week after the latest inflation data showed that U.S. consumer prices are far from easing.

Brian Overby, senior markets strategist at Ally Financial notes that investors might be inclined to sell their shares and get out. In fact, he adds that millennials have reduced their stock holdings in the last year more than any other generation.

"But history shows us this move can be a costly long-term mistake," Overby says.

Since 1957, he points out that the S&P 500 has fallen 20% or more from an all-time high nine times. But it has also bounced back higher within three years in eight of those nine times – 29% higher, to be precise.

"The takeaway? Staying the course could be your best bet. Market volatility comes and goes and can benefit those who think clearly about it," Overby says.

Here's an early market snapshot:

(Gertrude Chavez-Dreyfuss)

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TIME TO BUY THE EURO YET? BCA SAYS YES (0900 EDT/1300 GMT)

As the euro plunges to 20-year lows, BCA Research says it may be time to step in, arguing that the risk/reward now favors the single currency.

The euro EURUSD hit $0.98640 against the U.S. dollar on Sept. 6, before bouncing back to trade at $0.99605 on Friday. It has been hurt by concerns about an economic downturn, soaring inflation and an energy crisis as Russia cuts off gas supply as the region heads into winter.

However, BCA notes that European gas inventories have reached 84% of capacity, which is above the 80% target that the European Union set for November 1. Also, meteorological forecasts suggest that Europe will experience a warmer-than-normal winter, which will cut the use of heat, "likely making gas rationing unnecessary."

The government response to the crisis, meanwhile, also bodes well for the euro as "currencies fare best in loose fiscal/tight monetary environments. This is what Europe faces over the coming months, as governments boost income support for households and businesses, while ramping up spending on energy infrastructure and defense."

The European Central Bank has also started hiking rates and is unlikely to deviate from its tightening campaign as it faces rising inflation expectations. This has helped move interest rate differentials in favor of the euro since mid-August, BCA said.

The research firm said that it went long the euro against the dollar last week when it hit $0.99 and is targeting $1.06 by the end of 2022. The biggest risk to its view is a hawkish Federal Reserve, however BCA said that it expects U.S. inflation to ease over the coming months, before reaccelerating in the second half of 2023.

(Karen Brettell)

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