Well, if you were wondering if inflation and, in turn, interest rates were important to the stock market, this morning's initial market reaction to the CPI data cleared things up.

The Labor Department reported at 8:30 am eastern that the Consumer Price Index (aka CPI) rose by 0.5% in January, which was a tenth or two above expectations, depending on your preferred source. This was up from the 0.2% increase seen in December.

On a year-over-year comparison basis, which is key here, CPI was up 2.1%, which was also above the expectations for 1.9% and in line with the level seen in December.

In terms of drivers, the increase in consumer prices appears to be largely driven by higher costs for gasoline, shelter (think rent), medical, food and apparel.

When one strips out food and energy from the mix (because nobody really uses that stuff, right?) the so-called "Core" CPI increased by 0.3% in January. This was above the consensus expectations for 0.2% as well as the 0.2% seen last month.

On a Y/Y basis, Core CPI came in at 1.8%, which, as you have probably guessed by now, was above expectations by a tenth. However, it is worth noting that the Core rate is below the Fed's target level of 2.0%.

Market Reaction Was Swift

The market reaction was instant as the algos were primed and ready for the input. Dow futures went from +165 points to -340 points in a matter of minutes while the S&P futures plunged from +13 to -30.

What is interesting is while the yield on the 10-Year did rise to 2.87%, that level is not a new intraday high for the current cycle. Although, it is early and high-speed traders also play in the bond pits.

But... CPI is Not the Most Important Inflation Data

It is also important to note that the CPI is not the Fed's most closely watched measure of inflation. No, the pros prefer the PCE, or Personal Consumption Expenditure Index.

In addition, the CPI report showed that wage inflation, which is at the root of the inflation argument here, was muted. According to the Labor Department, Real Average Weekly Earnings fell a seasonally adjusted -0.8% in January and were up just 0.4% over the last 12 months.

But the key to the markets can best be summarized by the following sentence from the WSJ: "The report showed overall inflationary pressure intensifying."

Time For The "Retest?"

So, for those traders looking for a "retest" attempt to begin now that stocks have enjoyed a three-day bounce, this very well could be the ticket. Remember, the term "retest" is fairly vague. In my experience, the idea here is that after a sigh-of-relief bounce, the reason for the initial decline resurfaces and traders do some additional price exploration to the downside.

However, in order to be considered a retest, price doesn't necessarily have to reach last week's low. No, any move in the "direction" of the low will qualify. Sometimes, the retest is shallow and other times, the low is actually exceeded. But most analysts will agree, for a bottom to occur, a retest should be part of the process.

The key is that to be a "successful" retest, the volume and breadth statistics "should" improve during the test of the lows. So, we'll need to watch those stats today and tomorrow.

The bears are quick to point out that the rally from Friday's low was anything but robust and did not contain any "thrust" signals that tend to accompany big bottoms.

Summing Up

So, in sum, the bears have something to work with again today. Personally, I don't see the CPI data as a game-changer. Yes, the headline was a bit higher than expected. But the data was by no means shocking - or even worth raising an eyebrow over as there wasn't anything new in this report.

Finally, let's keep in mind that the Retail Sales data was actually disappointing, coming in a -0.3% versus expectations for +0.2%. So, couple this with the lackluster wage data contained in the CPI and it is hard to argue that inflation is getting bubbly.

But the algos are set react to any piece of data. As such, the initial volatility after the "higher than expected" number wasn't surprising. But for me, it will be more interesting to see what the markets do once humans get involved after the open and the "narrative" from today's data takes shape.

Thought For The Day:

We either make ourselves miserable, or we make ourselves happy. The amount of work is the same. -Carlos Castaneda

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

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At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.

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