The folks running the “market” apparently don’t care how obvious they’re being — tossing a 28% VIX smackdown into the mix to make sure that yesterday’s preposterous ramp job can hold for one more session.
What’s their game?
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ES came within 9 points of our next downside target before getting a nice bounce motivated primarily by USDJPY, which was working flat out to save the NKD from a scary, and long overdue dive to its SMA200.
This bounce will be quite important to the bulls, who are no doubt hoping to avoid a bearish 10/20 cross.
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Not that futures needed any help melting down this morning, but Jim Bullard just poured gas on the fire. Yes, Jim Bullard! The Fed president who never had a hawkish thought in his life.
"We were expecting an inflationary impulse, but this has been more than what we were initially expecting," says James Bullard. "The ideal path in my mind would be the 3% this year will be okay, and then we'll get it down to 2.5% next year and we'll converge to 2% from there." pic.twitter.com/i9vSio57GM
— Squawk Box (@SquawkCNBC) June 18, 2021
Then, he trashed the Fed’s most nonsensical policy: throwing $40 billion per month into the mortgage market when mortgage rates are already at all-time lows.
"I'm leaning a little bit toward the idea that maybe we don't need to be in mortgage-backed securities with a booming housing market and even a threatening housing bubble … we don't want to get back in the housing bubble game," says St. Louis Fed President James Bullard. pic.twitter.com/fDMkw9ckL9
— Squawk Box (@SquawkCNBC) June 18, 2021
Bulls better hope that ES can bounce at our next downside target: the 50-day moving average currently at 4174.
It appears that algos are finally being given the green light to (drumroll please) decline.
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Neither yesterday’s FOMC announcement nor Powell’s press conference produced any meaningful surprises. Yes, the dots shifted slightly, but everyone knows they’ll shift a lot more before long.
Futures easily reached our initial downside target and came within 5 points (so far) of our second. 
But, the real action was in currencies, which were finally turned loose. Look for EURUSD to finally reach our backtest target where it faces an enormously consequential decision.
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We’ve pretty much beat the inflation horse to death on these pages over the past six months. Bottom line, It’s too high and potentially out of control.
So far, however, the Fed’s been able to hoodwink investors and algos and commandeer the bond market. Aside from making things much more difficult for the little guy – who they claim to care about – there have been few negative repercussions.
But people are starting to talk. At first it was just fringe strategists like yours truly. Lately, it’s financial pundits, important bankers and hedge fund managers. Has the trance been broken? And, if so, will the market care? Today, we’ll finally find out how clever the Fed can be.
Two years ago, before any of us had ever heard of COVID-19, our charts already called for some pretty dramatic outcomes. We were pretty sure the 10Y, having reversed right on target at 3.25% in October 2018, was headed for at least 1.55%…
…a target that was adjusted to 0.15% — 1.33% on January 13 at which point Wuhan City had reported only 40 suspected cases and one death. On March 8, it reached 0.398% – well ahead of schedule thanks to COVID-19. 
Its rebound has been impressive – aided by a sharp rebound in inflation due primarily to the even more impressive recovery in oil prices.
Ah, oil… We became convinced in March 2018 that oil was headed for a major breakdown, noting important cycles in its peaks and troughs. At the time, our model showed WTI (then at $62) dropping below $20 in early 2023.
On Jan 3, 2020 we got more specific, pinpointing $17.12 on April 23, 2023.
Of course, it dropped much lower and much faster than that. And, it’s recovery has been higher and faster than anyone imagined (or the fundamentals would support.)
Interest rates and oil prices are irrefragably joined at the hip. Gasoline prices are especially highly correlated with inflation… 
…which has traditionally been highly correlated with interest rates. But, that all changed in the last couple of months when, thanks to the Fed’s ability to control interest rates, the bond market stopped caring about inflation.
The stock market was elated as short rates flatlined while the 10Y marched higher…
…leading to the first time in 20 years that a rapidly rising 2s10s didn’t lead to a market crash.
The Fed has pulled off a pretty masterful reinflation of the everything bubble. Are they clever enough to avoid the inevitable pop?
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Alarms are going off on multiple charts this morning, the day one of the most consequential Fed meetings in years kicks off.
The topic on everyone’s mind, the one we’ve been warning about for the last six months, is inflation. But, if you believe Jay Powell, it’s not even something the Fed’s thinking about thinking about. Just look at the bond market – nothing to worry about, right?
Wrong. The Fed says what they need to say in order to justify the massive stimulus being thrown at markets – said stimulus being sufficient (so far, at least) to keep interest rates from keeping pace with spiking inflation. Now, the Fed’s starting to sound just plain ignorant.
Not that the crowds are always right, but the growing chorus of inflation warnings is becoming harder to ignore. Will the Fed really push its luck and let inflation break out?
At this point, all algos seem to care about is rising oil/gas prices and falling volatility. That’s about to change. 
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There’s a growing debate amidst the punditry as to whether inflation is transitory and, if so, whether it matters. In an interesting WSJ article yesterday, James Mackintosh notes that “markets are leaving little room for the Fed to be wrong on inflation.”
With stock and bond prices so high relative to historical values, this is undoubtedly true. Mackintosh references Michael Pond, head of global inflation-linked research at Barclays, who recently noted that the Fed was right the last time it bet on inflation being transitory, in 2011. But, it’s important to recognize “why” the Fed was right at that time.
The problem with soaring inflation, of course, is that it can lead to soaring interest rates. Between Jan 2010 and Feb 2011, the 10Y had been averaging a 1.5% spread over CPI. After the Fukushima disaster in March, inflation began to outpace the 10Y — not because inflation rose but because the 10Y plunged due to the disaster and the sharp equity correction which began in July 2011 when US credit was downgraded.
In other words, the equity correction gave interest rates a nudge in the right direction, leading CPI by 7 months at which point the influence of falling oil/gas prices finally began to be felt. Fukushima and the equity correction produced a sharp decline in interest rates to which inflation eventually “caught down.”
By September, the relationship had flipped and CPI exceeded the 10Y by almost 2% — culminating in a central bank-induced crash in oil/gas prices in 2014-2016. Stocks were protected by the yen carry trade, which central bankers revved up in order to stimulate algorithms to go all-in on stock purchases.
By early 2015, the 10Y was back to a 2% spread over CPI as the oil/gas crash played out. The chart below shows both printed on the same scale.
But, of course, it also illustrates the shocking 3.3% spread between the 10Y and CPI. In Spring 2020, it appeared that the situation would ultimately be rectified by another 2014 or 2018-style crack in oil/gas prices – the point being to keep interest rates from running away from inflation. But, as in 2011-2012, exogenous events did the Fed’s bidding.
The COVID crash crushed interest rates to where the Fed, facing a nearly $30 trillion deficit, would eventually need them. The pandemic also gave the Fed all the ammunition it needed to justify QE so massive that the bond market’s price discovery mechanism was seriously damaged if not destroyed.
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By crushing volatility in the wake of yesterday’s record-setting CPI print, the Fed might have convinced some investors that spiking inflation isn’t a problem – even if it’s not transitory. The charts — and the math — suggest they might become skeptical again very soon.
The departure of CPI from the gasoline delta curve illustrates how inflation is no longer just an oil/gas problem – and thus wouldn’t be “fixed” by a modest decline or leveling off of oil/gas prices.
Can the algos be convinced to ignore both the math and the charts?
The 10Y has nearly reached the downside target we’ve maintained for the past couple of months, but would the algos ignore a breakdown? It seems unlikely.
Of course, there’s a fundamental argument as well. The biggest risk to rising inflation as far as the markets are concerned is higher interest rates. By crushing rates (and shorts) at a time when they would normally be spiking higher, the Fed has seemingly eliminated that threat.
Higher inflation will be hard on working stiffs across the country, of course. Higher car prices, gas, rent, food…the people the Fed swears it cares the most about are the least capable of absorbing these expenses – transitory or not. Unfortunately, the market could care less
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Will the Fed be able to stick to their “inflation is transitory” shtick this morning? If the financial media is any guide, there are plenty of adherents among money managers. And, why not? After all, there isn’t exactly a clear definition of what transitory inflation means. Is it elevated for 3 months? Six? A year?
When it was just oil and gas’ base effect driving the numbers, it wasn’t that tough to argue that CPI would decline from May’s highs as we approach the end of the year. Assuming gas prices hold current levels, CPI could peak at around 4.2-4.3% and begin a decline into the end of the year. 
But, with labor, used cars, food, medical, etc. all joining the march higher, there is a very real risk of a much higher print and an upward price spiral that won’t unwind any time soon.
In any case, look for stocks to finally express some doubts – depending on how broken the bond market turns out to be.
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You know when the market is in a holding pattern by how VIX behaves. For the most of the past three weeks, we’ve seen sudden collapses in VIX just ahead of the cash open. It doesn’t always last, but it’s very effective in reminding algos to smack the snooze button, “fixing” any overnight declines and sending ES back to within a few points of its all-time highs.
Almost every day for the past several weeks, investors have turned over and gone back to sleep. But, tomorrow, we’ll get some very important CPI and claims data that could change everything. Are investors in for a rude awakening?
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