The Fed and Goldilocks Are Set to Do Battle

The market has been chugging along for weeks due to the narrative that the battle against inflation has been largely won, the economy will remain strong, and the Fed will start cutting interest rates in the spring of 2024. It is a Goldilocks economic story with conditions that are not too hot to cause increased inflation and not too cold to cause an economic slowdown.

That narrative will be called into question this week as the market deals with economic reports, including CPI, PPI, and retail sales. In addition, there are several large bond auctions, and the big event is the Fed interest rate policy decision and the Jerome Powell press conference on Wednesday.

The bears are convinced that the market is far too optimistic about a drop in inflation, strong economic growth, and a dovish Fed, but they have been crushed by the very strong market momentum. The price action has been overwhelmingly positive and has even boosted many long-suffering small-caps and secondary stocks.

Momentum that is this strong doesn't die easily. The more that stocks run-up, the greater the concern about missing out, and that creates substantial underlying support and a large crowd of potential dip buyers. The anticipatory bears have been trapped numerous times in the last five weeks and have provided short-squeeze fuel as they are forced to relent as the indexes keep on running.

Technically, the indexes and many stocks have been overbought and extended for weeks, but there have only been isolated days of selling with no significant downside follow-through.

The big question this week is whether economic data or the Fed will produce a sell-the-news reaction. There have been several events in the past month that looked like good setups for a sell-the-news response, but each time, there was strong underlying support, and the bears were squeezed.

Another issue of importance that is not as well recognized is the 30-year bond auction that takes place on Tuesday. The last bond auction was very poor, and there was a strong market reaction that spiked up interest rates. These auctions usually don't generate a major response in stocks, but they are more important than ever right now.

The indexes are even more extended at this point, and even the bulls would like some downside so they can find better entry points. In addition, a sell-the-news reaction is so obvious that it is likely that there will be a crowd ready to buy the weakness.

It will be an interesting economic battle, but stay focused on the price action. There is not going to be any significant downside until dip-buyers lose confidence and the fear of missing out is no longer as strong.

We have some minor weakness on Monday morning, but the fireworks begin on Tuesday morning when the CPI report is issued.

At the time of publication, James "Rev Shark" DePorre had no position in the securities mentioned.