The market is due for some rest as we get the critical CPI report on Wednesday morning. The big move off the lows mainly came from the hope that inflation has peaked and is starting to trend down. A significant drop in gasoline, oil, and commodities has helped to feed that narrative.
The market has been so optimistic about peak inflation that it has been willing to ignore hawkish comments from the Fed and signs of a slowing economy. The very strong July jobs news -- which is inflationary -- was spun as an indication that the Fed can continue to raise rates aggressively without creating a recession.
This morning it will be very instructive to see how the market reacts to the CPI report. It is expected that the annual CPI report will fall, on an annual basis, to 8.7% from 9.1% in June. On a monthly basis, there should be a very large drop from 1.3% in June to 0.2% in July.
Clearly, energy and commodity prices have eased, but the focus will be on labor costs and housing. Rents remain very elevated, and demand for labor is driving wages.
Regardless of what the CPI report shows, the real issue is whether or not it changes what the Fed does in the months ahead. Chances of a 0.75% hike in September have increased, and hikes could continue into 2023.
Then there is also the issue of a soft landing. Although the Fed has had little success in engineering a soft landing in the past, the market appears to be optimistic that if there is economic slowing due to rate hikes that it will be shallow and brief. That is the hope, and there really is no hard evidence to show whether that course of events is likely or not.
Stay focused on the price action. I expect to see some reversals in both directions as the CPI news is digested. The PPI report is due Thursday, and that will be another market mover.
I've raised cash levels over the last week, and there are many stocks I'd like to add on pullbacks, but I'm going to stay patient while today's news is digested.
