All eyes are on US inflation today. It could be a big one!!!

Whatever has happened so far this week is pretty irrelevant.

That may seem like an odd statement, but in a week where we get a US inflation update, it’s true. That release is today, and the market is on tenterhooks.

While ‘anything could happen’ as always, and the least likely thing often does, we see the most probable outcome as a negative one for the stock market. Interest rate cuts are priced in and the market has rallied for 2 months. It feels a lot like all good news is priced in, yet we haven’t actually seen any particularly good news. The best we’ve had is that the bad things are perhaps fewer than they were.

The market has rallied almost entirely on the hope that inflation is dissipating, and rates will soon start to fall. This former is true right now, the latter most likely, but there’s still a lot to be wary of.

Here is the month-over-month inflation number for the last year. It has cooled, but it needs to stay between 0.1% and 0.2% to hit target.

What if the data shows any sign, even a small one, that the drop in inflation has stalled?

Traders’ focus is on Thursday’s US inflation figures as the market seeks clues on the timing of Federal Reserve interest-rate cuts. The cooling in headline inflation is set to reverse in the December data,?according to?Bloomberg Economics, deterring the Fed from delivering the rapid and deep interest rate cuts markets have priced in for 2024.

If we look at this chart below, we can see the December 2023/2024 rates spread. This is the expected difference between the interest rate in the US as of Dec 23 and Dec 24. As you’ll note, it has fluctuated a great deal but currently sits at around 145.5 basis points. That is 1.45% over the year.

Expectations are high. They could get higher, but there is a lot more room for disappointment that not.

The expected numbers are 0.1% for the overall inflation and 0.3% for Core Inflation month-over-month. If they are in line, that’s a good sign, but how much more can we rally? If they are higher, this will be taken very badly indeed.

The stock rally since the start of December is inversely related to the above graph. ?

Another headwind could come with the approach of earnings season in the next few weeks, with analysts?slashing estimates?in the run up to the announcements.

“The market remains susceptible to fears that it may have priced in too many Fed rate cuts this year and also to nervousness that earnings season may not produce the results that justify the run up in stock valuations into the end of last year,” Rabobank strategist?Jane Foley?wrote in a note.

(At this point though, we would also state the earnings are almost always better than market expectations. It’s just human nature.)

Government bonds have risen a touch this week, with benchmark Treasury yields dipping back below 4% briefly although they finished the day around 4.01% yesterday. Investors are clearing the way for a wave of?supply?that will total $2.1 trillion over the next several weeks.

Government bonds have been in demand this week with Belgium seeing a record 75 billion euros of demand for a 10-year bond sale on Tuesday, while Italy attracted nearly 150 billion euros of demand for two bonds. The amount raised of 15 billion euros also matches the highest ever in Spain's history from the April 2020 bond sale, the Treasury said.

Geopolitics remained in focus, as China’s US envoy said the country had no room to compromise with those advocating for?Taiwan independence.

Emerging-market stocks?slipped?to a four-week low as new hotspots of political turmoil erupted in Ecuador and Poland. In Poland, police arrested two former ruling party officials at the presidential palace, escalating a constitutional crisis three months after a pro-European party won power. In Ecuador, government forces battled a wave of violence by gangs.

US stocks traded in a relatively narrow range yesterday with many investors clinging to sidelines ahead of the key inflation?report. We have noticed the same with several of our strategies on TPP. As one of them said, ‘I would rather be out, wishing I was in, than in, wishing I was out’ (wise words).

The pain of being wrong outweighs the benefits of being right sometimes and nobody ever got fired for being cautious.

So far this week most European Indices have been trading flat with not much to report. The surprise of the week is that US indices seem to have pushed slightly higher. Many analysts are wondering just how this is possible and whether it can be sustained.

Many of the large US tech stocks are now trading at multiples not seen since the post COVID rally, which then blew up in 2022. We aren’t saying that will happen again, but the reason for such a big rally doesn’t really stack up.

That said, sometimes stocks rally, and sometimes they don’t. It’s a difficult thing to judge and people only know which way the market will go after it’s happened. For now, we’ll sit and watch what happens with US CPI. After that, we can get back to doing what we do.

Brent crude rose above $78 a barrel in a choppy session yesterday following more?attacks?on vessels in the Red Sea that could upset both oil supplies and trade flows. It dipped back below before the end of the day as things settled.

So, that all said, our eyes are now fixed firmly on the US inflation data at 8.30am eastern and 13.30 UK time.