Following a significant reversal to the downside on Thursday, the market rested and consolidated as it finally started to recognize that the Fed will hike rates more than previously believed.
For a long time, the bullish narrative was that inflation has peaked, and that would cause the Fed to partake in a dovish pivot. The bears argued that while inflation may be coming down, that likely means significant economic slowing.
Of course, this relatively simple scenario did not play out as expected as the economy has ended up much stronger than expected, and that is causing a rebound in Fed hawkishness. Many investors have taken the position that the very strong market action is confirmation of a likely Goldilocks economic scenario.
After several hotter-than-expected economic reports and some hawkish comments from various Fed members, the market finally gave into the pressure and cooled off a bit. The likelihood of higher rates for longer has grown substantially, but the market is still resisting the potential impact of that policy.
The bears underwent a substantial short squeeze. According to Reuters, the short covering from Jan. 31 to Feb. 15 was the second largest in magnitude over any 12-day period in the last decade. This clearly proves that much of what drove the upside action was poor positioning rather than great fundamentals and economic news.
The question is whether the bears reload and put pressure on the market. They have the Fed in their favor, and the last two weeks of February are seasonally weak. Seasonality is a tendency and not a certainty, but the technical conditions combined with the news flow may give the bears an advantage.
Earnings season is over, and there will be intense focus on economic news, but without shorts to squeeze, it may be harder for bulls to regain their footing.
Have a great long weekend. I'll see you on Tuesday.
