Ever since the Consumer Price Index hit a peak of 9.1% in June 2022, there have been bulls pushing the narrative that peak inflation and a steady downtrend would cause a Fed pivot and bring an end to the bear market. It is not an illogical argument. Inflation and a hawkish Fed are what caused the bear market, so they are the issues that should end it.
The days of rate hikes of 75 basis points are over, and after the soft December CPI report on Thursday there is a likelihood of three more hikes of 25 basis points each. This belief has given the bulls hope that the market has seen the lows and is now slowly crawling out of the nasty bear market.
Several Fed members are arguing that the market is far too optimistic about what will happen. While the Fed says there will be no rate cuts this year, the market is anticipating that the Fed is wrong and that it will start to cut rates at the end of 2023.
According to The Wall Street Journal, San Francisco Fed President Mary Daly said, "To be honest with you, I don't quite know why markets are so optimistic about inflation. I think of them as priced for perfection." Likewise, St. Louis Fed President James Bullard said, "It could be that inflation starts to go in the other direction again, and then the Fed would have to react to that. I don't think there's enough pricing being put on that possibility."
The market just doesn't want to embrace this caution. Part of the reason is that there is a belief that the Fed is intentionally trying to talk down the market in order to keep inflationary pressures created by a strong market under control.
Consumer inflation isn't the only issue bothering the Fed. There is still wage inflation and the potential for slowing growth.
The message here is that the Fed is not likely to give the bulls what they want and will start to signal a pivot. There will be a constant parade of hawkish Fed comments. We may have seen peak inflation, but that doesn't mean that the Fed has won the battle.
Bank earnings are rolling out here on Friday morning and so far are OK, but the primary issue there will be forward guidance. We will find out quickly what the bank CEOs see the economy doing in the year ahead.
Technically the indexes are a bit extended and we still have conditions for some sell-the-news action, but stock picking is looking very good and small-caps are leading. That area will be the focus of bullish traders for now.