Thursday’s US CPI report for September will be massive. It could be a big problem for the stock market, potentially sending the Invesco QQQ Trust Series 1 [QQQ] – an exchange-traded fund (ETF) based on the Nasdaq 100 Index – 10% lower, according to my technical analysis. Markets have been betting that inflation has peaked and that declining inflation would prompt the Federal Reserve to soften its stance on rate rises, perhaps even leading to rate cuts. But to this point, that narrative has struggled to gain a solid footing.
It has struggled because inflation rates aren't cooling, and the job market remains hotter than expected. The recent jobs report showed that the unemployment rate fell to 3.5% in September, down from the previous month's 3.7%. On top of that, the CPI inflation rate has been above 8% every month since March.
Consensus estimates may be too low
Analysts now estimate that CPI in September rose 0.2% month-on-month and 8.1% year-on-year, which may be on the low side. The Cleveland Fed sees CPI increasing by 0.3% m/m and 8.2% y/y, which could be a cause for concern since the Cleveland Fed has underestimated the y/y inflation rate in 15 out of the last 19 reports, while underestimating 17 of the previous 19 m/m inflation reports. In other words, if the consensus estimates are below the Cleveland Fed estimates, and the CPI typically runs higher than the Cleveland Fed estimates, there is a good chance that consensus estimates are too low.
A hotter-than-expected CPI would likely send equity markets sharply lower, as it could kill the last glimmer of hope that the Fed might pull back on rate hikes anytime soon. It could even raise concerns among traders that the Fed could raise rates by 0.75 percentage points (75 basis points) in November and another 75 bps in December. That would exceed current market expectations for rate rises totalling 125 bps by year-end.
Markets may be expecting hotter inflation
A hotter report may not surprise the bond market because Treasury rates have been reflecting very negative price patterns but very bullish patterns for rates. It could even lead to the two-year US Treasury note rising to almost 4.8%. The two-year US Treasury note has formed a bullish flag pattern, and a projection of that flag is what opens the path to around 4.8%.
This could also push up the rate on US 10-year Treasury inflation-protected securities (TIPS), as it appears to have an ascending triangle pattern. The rate has been rising and consolidating between 1.4% and 1.7%. This consolidation has created a bullish continuation pattern known as an ascending triangle. This bullish technical pattern suggests that if the rate rises beyond 1.7%, the 10-year real rate could climb above 2%.
A move higher in the 10-year real yield would be a significantly bearish indicator for the iShares TIPS Bond ETF [TIP]. When TIP rises it indicates that real yields are falling, and when TIP falls, it means that real yields are rising. Therefore, if the 10-year rate begins to push toward 2%, it would push the TIP ETF lower. The ETF has the opposite pattern of the 10-year TIPS rate, a bearish descending triangle, with technical support on the ETF around $104.50. A break of support signals the potential for further losses.
But the big news is what it would mean to the Nasdaq-based QQQ ETF. Because the QQQ has just followed real rates for the past five years, with the QQQ rising when the TIP ETF increases and the QQQ falling when the TIP ETF falls, a breakdown in the TIP ETF on rising real rates would push the QQQ to new lows.
With support currently at $260 in QQQ, a push below that level potentially sets up the QQQ for a decline to around $250 and potentially back to its pre-pandemic highs of about $240. It may sound far away, but we are talking about a drop of about 10% from its current levels.
A relief rally is still possible
A CPI report that comes in 0.1 or 0.2 percentage points hotter than expected could trigger a series of events that could result in stocks dropping another 10% quickly. Likewise, if the CPI report should come in as expected or cooler than expected, it could result in a significant relief rally, sending rates lower and the stock market higher. Given that the market appears to be set up for a hotter-than-expected report, an inline or cooler report could lead to a big move higher in the QQQ, sending it back above $300.
This will undoubtedly be a critical CPI report and a must-watch event.
Charts used with the permission of Bloomberg Finance LP. This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer's views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer's analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer's statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment. Michael Kramer and Mott Capital receive compensation for this article.