On Thursday, Fed Chairman Jerome Powell and the European Central Bank reaffirmed that they plan to raise interest rates aggressively to battle inflation. There were no hints about how long it would take or when a pivot to a more dovish stance would occur.
The market stumbled early on the day on the comments but shrugged off the concerns in the afternoon and was able to build on the oversold bounce that started on Wednesday. The hope is that we are seeing peak hawkishness from the central banks and the worst may have already been discounted to some degree.
Market participants also hope the August Consumer Price Index (CPI) report next Tuesday may come in lower than expected and signal that inflation has peaked and is starting to trend down. This optimism about inflation was what helped to drive the big rally in July and August. The market ignored consistently hawkish comments from various Fed members until Powell reminded everyone that the Fed really was serious about inflation and would persist even if it meant slowing the economy and creating higher unemployment.
The market is again starting to ignore clear comments from the Fed. Part of the reason is that the Fed can't hint at a potential pivot without undermining its message. If Fed members make it clear that they think the battle will be won in a few months, then the negative impact of the Fed's hawkish policy will be diminished and less effective.
Bulls are intently focused on the idea that inflation has already peaked and will continue to trend down quickly. However, the issue the Fed is concerned about is how long inflation stays at elevated levels. The biggest problem is if it becomes entrenched as it did in the 1970s then the battle needs to be fought repeatedly. Peak inflation makes for a good headline, but the real issue is the pace of a downtrend.
CPI in China came in lower than expected due largely due to Covid lockdowns that are hurting the economy, but that is helping the action here on Friday morning. Oil is bouncing back after a two-day slaughter and it will continue to be a focus.
At this point, we have a pretty typical counter-trend rally in a bear market. These rallies always cause a large number of folks to believe that the worst is over. That is why they move so big and so fast. If traders didn't believe that a bottom may be forming, then they wouldn't be as willing to buy.
There has been a tendency for premarket strength to fade recently, so we will see what happens.