Investors Surprise, Buy Bad Inflation and Rate Hike News
The CPI came in hotter than expected and I was surprised by the reaction.
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The much-anticipated CPI report came in hotter than expected Friday morning, triggering an immediate jump in Fed funds futures. The odds of a rate hike at the September 16 meeting now stand at 86%, and the odds of a hike before the end of the year are at 97.6%.
That interest rate response to the report was not surprising. What was surprising is that stocks jumped higher on it. The S&P 500 gapped up at the open and closed near where it started, up about 0.9%. Small caps lagged with a gain of 0.5% and breadth was only about 55%. Apple (AAPL) was strong for a second day and helped boost the indices. Oil was down, which helped, but bonds did not hold their early strength and closed with minor gains.
Buy the Bad News
This is exactly the setup I described on Friday morning. Investors had already positioned for a hot CPI and a Fed hike, so the report did not tell them anything they had not already sold. What we got was a “buy the bad news” response, the inverse of the more familiar “sell the good news.”
The mechanism is the same in both directions. When a market has fully priced an outcome, confirming that outcome removes uncertainty, and removing uncertainty is bullish even when the news itself is bad. The hike odds have swung wildly for two weeks, from 35% to a coin flip to 71% and now to 86%, and every swing was a source of volatility. Friday’s number effectively settled it. The Fed is going to hike, the market knows it, and the endless speculation is over.
That is worth more to this market right now than a soft number would have been. A soft print would have reopened the question of what the Fed does next. The hot print ended the debate and that means that we can be more confident about making some moves.
Do Not Get Carried Away
One good day does not undo what built up over the past two weeks. The reaction was encouraging but the internals were not spectacular, with breadth at 55% and small caps lagging. A gain that depends on Apple and big caps is not the same as buying across the board.
The bond market is the tell to watch from here. Bonds gave back their early strength and closed with only minor gains, which means the long end is still under pressure even on a day the stock market wanted to rally. The 10-year is sitting on the edge of 5%. Until that stabilizes, any equity bounce is working against a headwind that has not gone away, and oil at $100 with the war unresolved keeps the inflation input elevated regardless of what one CPI print said.
Game Plan
I said on Friday morning that a hot number and a negative reaction was the outcome I wanted to buy. We got the hot number but I was surprised by the immediate positive reaction. I expect a hot number to trigger some immediate selling. That gap up is not something I wanted to chase when the news was bad and the market rallied anyway, because that kind of move often gives some back before it goes anywhere.
Today’s action improves the odds that a bottom is forming. The market absorbed the worst realistic outcome on the rate question and went up. That is the behavior you want to see at a turn. It is not confirmation of one, but it is the first piece of evidence in two weeks that points to an improvement in price action.
I will be watching Monday to see whether the buyers stay engaged or whether this was a one-day relief move that fades, and I would rather buy the first constructive pullback than the third day of a bounce.
Next week is the Fed meeting, and even if a rate hike is now a near certainty the policy discussion will likely produce a high level of volatility.
Have a great weekend. I’ll see you on Monday.
At the time of publication, DePorre had no positions in any securities mentioned.
