Hey There Income Hunter,

We have witnessed an incredible one-month drop in inflation. The media was giddy over the drop, and it certainly helps …

But there is more to the numbers than the headline print.

Excluding energy, consumer prices in July were 0.4% higher than they were in June. The decrease was primarily due to gasoline prices, which fell 17%.

Food and rent continued to rise, with food +1.1% and rent up another 0.6%. These categories – as with energy – are the absolute essentials.

Energy is a real wild card, especially as Russia holds most of the cards and importers of oil are desperately in need of supply. 

So, the good news is we have had a fantastic run in the markets as inflation has come down so fast …

The not so good news is the year-over-year report of 8.5% is the highest in four decades, so what happens if energy prices go back up? 

Today, we will look at the probabilities of stocks continuing to rise as financial conditions get tighter in the months ahead. 

First let’s take a look at what Fed officials have had to say the past couple of days …

1. Evans: I’m positive forecasting that next year, core PCE inflation will be nearer to 2.5%

2. Evans: I don’t expect the economy to slow significantly anytime soon.

3. Kashkari: We may be in a recession in the near future.

Does this sound like a Fed that knows what they are doing? 

The Fed is about to start sucking $90 billion out of the financial system and they can’t even agree on where the economy is going!

The market is celebrating the (presumed) end of interest rate hikes, but what is worse for the market is quantitative tightening (QT). 

QT is set to go on indefinitely, which means until something in the system breaks.

We have seen this movie before – specifically, in 2018 when the Fed started with rate hikes, went to QT and then increased QT. Have a look:

Today, the Fed is dealing with a much worse situation than 2018 due to much higher debt plus much higher inflation.

The combination of high debt and high inflation pretty much guarantees there will be no soft landing.

I am sure the Fed is not happy about the +17% rally in the S&P 500 index (Ticker: SPX) since they need as much help getting inflation down as possible.

The bond market has not traded as if it believes inflation will continue to fall. Check out the move in iShares 20+ Year Treasury Bond ETF (Ticker: TLT) this week:

If interest rates plunged along with softer inflation, then yes, that would be supportive of higher stock valuations ….

However, with so much leverage and so much debt in the financial system, higher rates plus QT could send fear back into the markets.

We are entering a critical period of the year, which historically is a difficult environment for financial assets. Check out the 20-year VIX average monthly seasonal trends below:

The bottom line is this: July gave the market what it was hoping for, and now it is searching for the next narrative. 

This rally has run out of steam and would need a new bullish narrative to continue higher. The Fed will not be providing that next stimulus the way they did in the past. 

Bring It Home

The 4,200 level in SPX is critical. The open interest is massive at that strike with standard option expiration coming up next Friday, August 19.

So, SPX 4,200 and SPDR S&P 500 ETF (Ticker: SPY) 420 will pin the market through option expiration (OPEX). Then we will be heading into a historically high volatility time of the year. 

Breaking the 4,200 level post OPEX will be the first sign of a potential resumption of the down trade. 

Stay tuned and as always …

Live and Trade With Passion My Friend,

Griff