Over the course of the last week, equity markets have rallied.

The main catalyst is tomorrow’s highly anticipated CPI report. The market is hopeful that a lower headline CPI number, coupled with last week’s jobs report which indicated that hourly wages have stopped rising, will be enough for the Federal Reserve to declare victory on inflation and take less aggressive action when they announce their policy decision on February 1st. 

We were alerted to a note from Jim Bianco of Bianco Research that may help those attempting to sort out the short-term implications of tomorrow’s report.¹

The market is expecting deflation. The chart below indicates that the median prediction for December month-over-month CPI is -0.1% (the high estimate is +.3%.). 

Bianco makes the case that deflation is therefore already priced in. 

The chart below shows that year-over-year core inflation is expected to fall from 6.0% to 5.7%. As we know, core inflation is the most important number for the Federal Reserve.

Bianco goes on to say that the market “wants to believe" that -0.1% will be a stunner and causing the Fed to “only” hike 25 basis points on February 1st. He also rightly points out that these expectations are “priced into” the ongoing rally and must “be beaten” with even lower numbers for the market to rally further.

It’s ridiculous that our markets have become completely and utterly beholden to a few data points. Unfortunately, the Federal Reserve’s mistakes have now put everyone invested in stocks and bonds in a similar, topsy-turvy boat. 

As markets flip flop around tomorrow, we offer the following TWO reminders:

1. Research indicates that bear markets do not bottom until the VIX (Volatility Index) hits 40. Today it closed at 21.² 
   
   A recent analysis by equity strategists at BNP Paribas concludes that the VIX is a reliable indicator of market capitulation and, therefore, useful for determining whether the bear market has come to an end. They found that the median VIX level at past bear-market bottoms was 40.5, well above the VIX’s highest level hit (at least so far) in the current bear market (which is 36.45). Furthermore, since the firm found that spikes “in volatility have on average come at the same time as the trough in the market,” they conclude that the bear market has not yet hit bottom.³
2. Research also indicates that bear markets don’t hit their bottom until after the Federal Reserve is finished hiking interest rates.⁴

As we have highlighted above, the Fed is expected to raise 25 basis points next meeting. 

At some point, investors will stop believing the data altogether. While the Consumer Price Index has regularly been modified over time, and therefore not representative of true inflation, last month’s numbers appear to have been leaked a full minute ahead of their normal time of 8:30am EST. 

According to Bloomberg, on Dec. 13, the monthly CPI, one of the Federal Reserve’s favored inflation measures, was scheduled to be released precisely at 8:30 a.m. as usual. But something odd happened in the 60 seconds leading up to it. Trading volume in 10-year Treasury futures soared, reaching three times the level seen a minute before the release of any of the last 24 CPI reports.⁵

“The volume of trading was quite extraordinary,” said J. Christopher Giancarlo, head of the Commodity Futures Trading Commission during the first part of the Trump administration and now senior counsel at the law firm Willkie Farr & Gallagher.

In less than 60 seconds, algorithmic trading pushed the futures market for the S&P 500 higher by more than 50 points, and the yield on the 10-YR Treasury dropped 7 basis points, all while hundreds of millions of dollars changed hands.

More fake news in a rigged economy sums it up. 

So, while tomorrow could see another “risk-on” rally in the near term, we recommend not getting fooled. Research suggests our equity markets have yet to bottom. We anticipate that the smart money could look to take advantage of the near-term momentum and “sell the rip” rather than continuing to “buy this dip.”