The Setting

In the past few days the market has seen a surprising bounce. The question has arisen, why? Jerome Powell spoke at length with the Cato Institute and once again delivered his message that the Fed is going to fight inflation to the very end. Their goal is absolutely the 2% target we’ve all become familiar with. Every Fed governor and spokesperson is continuing their hawkish stance. Brainard for instance, said (and I am writing this off of memory only) that concerns about over tightening are a question for later. Implying that the principle concern continues to be inflation, not overtightening (the bull thesis)

The Psychology

So why are we bouncing? Why is risk getting put back on? This is the question that has taken hold in the market the past few days. I think it will become increasingly clear what the market is betting on.

CPI Data.

On Tuesday September 13th we’re going to get CPI data. It’s predicted that the MoM reading will show a negative number of -0.1% and the YoY will drop to 8.5%. A lot of this has to do with the drop in gasoline prices. Employment reports have also been positive on slowing wage growth, so there’s ancillary evidence to expect a drop in CPI.

Because the headline number could see a drop it’s going to draw in bulls. The Fed is looking for a series of data points before they back off, but the bulls are going to want to ‘run ahead’ of that series. It’s a risky plan, but that’s probably the psychology at work. The people who get it right could be generously rewarded–but if they are wrong they will feel pain.

If CPI drops more than expected, I would expect a more frothy rally. If it CPI doesn’t drop as much as expected, expect it to evaporate quickly and the downtrend to take hold.

Evidence

But is there evidence for this or is it all just conjecture? Let’s look at a few charts:

Above is a pair of images of the 1D and 4 hour time period charts for the $SPY ETF. What’s clear to me is that we’re seeing a sharp change in momentum towards the upside on almost all indications. Bears are retreating and bulls are moving in (DMI indicators). The market looks to be approaching a resistance line as well.

I believe these are the ‘bets’ being placed on risk assets ahead of the CPI print. These are the people running at the front of the pack. They are looking to be rewarded on Tuesday.

As I wrote above, if the CPI shows some cooling off expect it to take hold in the minds of traders. They will look to profit off of the good news on inflation.

How far can it go? Well, there are two clear lines of resistance at 411 and 437. Given how close we are I would expect a good CPI print to smash 411 and we could spend some time running higher. I do expect, however, for it to ultimately fail and become another bear market rally.

If you examine a number of charts you’ll see the same behavior forming in them as well so if there’s a rally off of CPI it’s going to have breadth. Take a look at $AAPL next:

The resistance here looks to be 163$ a share and possibly up to 175. I believe $AAPL might form ‘triple’ top, reach a new ATH, or make a lower high. It’s difficult to tell and very much depends on Tuesday’s data.

The Fly in The Ointment

So what’s the issue? Isn’t this great news? Inflation is backing off and that should be bullish. It is, but it also isn’t. Take a look at the zillow rental data and you’ll see why:

https://www.zillow.com/research/data/

This is a quick and dirty plot of the 102001 rental data for the united states. You can see a sharp movement up on the right side of the graph. The last data point is dated for 2022-07 and the first data point is dated for 2014-01. This is where the concern about inflation is now. It’s in shelter costs.

Is it getting better? It is not. Rent is continuing to rise at about 1% per month across the country. It is only continuing to pressure consumers. As leases expire and get renewed, higher and higher costs will be hitting those folks. This could explain why Core CPI is not expected to roll over:

Core CPI (MoM) (Aug): 0.3%, Core CPI (YoY) (Aug) 6.1%. are the current predictions.

This is ultimately what I believe will cut the Bulls’ legs out from under them. They are going to celebrate a roll over in headline CPI but inflation is embedded itself elsewhere in the economy. This is going to continue to pressure the American consumer and should show up in earnings.

So, to summarize, while we may have a celebration and risk on rally over a rollover in headline, beware that it is probably doomed. It could last for weeks like we saw previously, but eventually reality will weigh in.

I’ll take a small bullish position here to profit from the bounce, but I have no intention of holding onto it. The tide could turn very quickly depending on how fast a re-think of a roll over occurs.

As always, trade carefully, trade wisely. Please consult the appropriate financial professionals for any decision you may make. I am not a professional and none of this is financial advice and should not be taken as such.