Another Classic Event Day

What a face ripper.  Yesterday took the face off the shorts with a dull knife from open to close.  Its the crack cocaine for investors, the intermittent face rippers that get paper napkin chartists excited about bullish hammers and the paper napkin statisticians excited about breadth thrusts.  It has no meaning for the destination of this bear market.  And it has only a small edge in predicting the short term path.  

It all goes back to investor positioning around event days.  With the fear and uncertainty of another possible big down day on a hot CPI number, you had the market selloff for 5 straight days into the CPI number.  Investors have short memories.  They remember the cliff dive drops from past CPI numbers this year, and they were proactive in taking down long equity exposure ahead of it.  When long exposure is light ahead of a big, bad feared event, the weak hands have mostly sold, so while you can get a knee jerk reaction down on bad data, as stop losses get hit and short term liquidations occur, it can't stay down because a lot of investors who were nervous already sold down their positions.  And there were quite a few who were waiting to buy after the CPI, so you had buyers waiting for the uncertainty to clear to go in.  It only helped the situation for the bulls when the gap down was so large that it felt like a short term capitulation that flushed out any remaining weak longs. 

And as the market started rallying, you got the short squeeze for those who put on daytrading shorts after the hot CPI release.  And don't forget all the put hedging that went on the past few days, to hedge the event risk.  All of that got unwound as dealers had to delta hedge their short put exposure by buying index futures as the market went higher.  And this is a negative gamma environment, so dealers exacerbate moves because they have to buy when it goes up and sell when it goes down.   

A day later, after the dust has settled, that hot CPI number doesn't really change anything.  The STIRS market was already pricing in nearly 100% odds of a 75 bps hike in Nov., and it remains that way.  It did price in much higher odds of a 75 bps hike in Dec., as well as a higher terminal Fed funds rate, up to 4.85%.  If you think the Fed will still remember this CPI number at their December FOMC meeting, or any meeting after that, I have a bridge that's for sale at a bargain price.  

And no, the Fed will not go 100 bps due to this number at their November meeting.   If they did, it would invert the yield curve like you wouldn't believe and crash the stock market so fast it would actually speed up their pivot, not slow it down.  

If you read the FOMC minutes, it was more neutral then the initial hawkish reaction in September.  Here is a quote from the minutes that tells you they are not completely oblivious to the damage going on:  “it would be important to calibrate the pace of further policy tightening with the aim of mitigating the risk of significant adverse effects.” 

The stock and credit markets are likely to have major convulsions before the CPI or NFP numbers get to levels that the Fed is comfortable with.  Then it will be up to Powell to make his call.  Cause an even bigger recession waiting for the CPI to get down close to 2% or cry uncle and make a U turn, making everyone at the Fed look like fools again for their shoddy forward guidance.  Looking at Fed history, I'll put my money on the side that he cries uncle and gives up on his Volcker Jr. act.  

It appears the bond vigilantes are back in some countries, with the UK being the latest addition.  U-turn on the mini-budget that caused a huge stir, sacking Kwarteng, the guy who came up with that mess, etc.  If the UK gilt market didn't selloff so hard, none of that would have happened.  Without QE, the bond market can put extreme pressure on politicians trying to pass budget buster legislation.  But that trend will not last for long.  The temptation to do QE to act as a quick fix is too great.  Its always much easier politically to have the central bank buy up the bonds that they issue to finance their huge deficits, keeping rates artificially low and letting the currency be the release valve.  More people will complain about losing money in their stock and bond portfolios than about a drop in the value of their home currency.  

Post CPI, the SPX has room to run up higher, as the biggest event for the month is over.  With all that de-risking you saw over the past few weeks, there is a decent amount of potential energy for a bounce.  You could definitely see a relief rally back up towards 3750-3800 by next week.  It would be another good short selling opportunity if it happens.  Neutral at the moment.  I would focus on retail favorites as the best short candidates in the next bear market rally.  Unlike hedge funds, retail investors are still highly overweight stocks and will eventually be underweight by the time you reach the bottom of this bear market.