Mid-week market update: Yesterday’s hot CPI report finally convinced the market that the Fed is serious. For weeks one Fed official after another gave the same message: We will raise rates to about 4% and hold them there while we evaluate the inflation picture. We don’t want a repeat of the 1970s when the Fed prematurely eased while inflation pressures were still strong.
Former Fed Vice Chair Richard Clarida said in a CNBC interview
, “I think they’re going to 4% hell or high water, if I had to put it into two boxes. They are data-dependent, but that’s why they’re going to 4%. Inflation is way too high.”
The market is now discounting a 75 bps move next week with about a 25% chance of a 100 bps. The terminal rate is rose to 400-425 bps from 375-400 bps before the CPI report.
While the intensity of yesterday’s slide was a surprise, a stock market slide was not unexpected. I pointed out that the market was vulnerable to a setback. The VIX Index had recycled from above its Bollinger Band, which is an oversold signal for the market, to its 20 dma. Such events have typically resolved in a stall in rallies. As well, yesterday’s sell-off left an island reversal top, which is also an ominous technical sign.
I also alerted readers that the Cleveland Fed’s August inflation nowcast was above consensus expectations. Ahead of the CPI report, my social media feed was filled with chatter about how soft the print was going to be, indicating excessive sentiment for a dovish pivot and risk-on rally.
of Ned Davis Research found that, historically, the DJIA struggles but is marginally positive whenever headline CPI is higher than core CPI, which is the case today.
More downside potential
Traders were undoubtedly disappointed by the CPI report and the overly bullish positioning led to a -4.3% skid in the S&P 500. While the TRIN spike was a sign of a selling stampede, none of my other tactical bottom indicators are flashing buy signals. I interpret this to mean that there is unfinished business to the downside. The market’s inability to stage any meaningful reflex rebound after yesterday’s massive down day is disturbing.
pointed out that there is a 50-day VIX cycle, with the scheduled top on Monday, September 19, 2022, which is just before the start of the two-day FOMC meeting.
This is consistent with the FOMC cycle that I’ve noticed in 2022. The market has tended to weaken and bottom either just ahead or coincident with FOMC meeting day.
My inner investor remains neutrally weighted at roughly the weights specified by investment policy. My inner trader remains hesitant about taking a position. The usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator (ITBM) just flashed a buy signal when its 14-day RSI recycled from an oversold condition. In light of the bullish headwinds that I just outlined, the risk of a buy signal failure in the manner of the model choppiness during the August-September 2020 period (circled) is a strong possibility.
My inner trader concludes that the prudent course of action is to stay on the sidelines. It’s probably too late to sell but too early to buy.