One of the primary justifications for the recent market strength is the argument that inflation has peaked and that the Fed will 'pivot' to a more dovish stance sooner rather than later. The sharp drop in oil, gas, and commodities has given the argument some traction, but the big move in the market has created a potential 'sell the news' setup.
The market has been pricing in this optimistic view of inflation and has even been ignoring more hawkish comments from Fed members in recent weeks. The market even spun a very strong July jobs report as a positive rather than potentially inflationary.
The CPI report on Wednesday is going to cause a more careful examination of the issues of inflation, a hawkish Fed, and a potential recession.
The bullish narrative is that the worst has already been fully discounted, and that is why there has been such a strong move off the June lows. The bearish narrative is that there is still a tremendous amount of economic uncertainty to deal with and that the recent strength was primarily caused by poor positioning rather than a major shift in the macro-economic environment.
That is the setup for tomorrow and what we are seeing today is some positioning in front of the news. There is some concern about a 'sell the news' reaction, and that is causing mild selling so far. Breadth is running more than 2 to 1 negative, and speculative action has slowed substantially. Small-caps are lagging, and most of the meme plays and short squeezes have lost their momentum.
I've raised cash during the recent rally and am proceeding with a very high level of caution. My feeling is that with negative seasonality lurking and many economic data in front of the next Fed meeting, there is a high risk of some corrective action. I'm not wildly bearish, but I plan on playing some stout defense right now.