Nothing is more important than the CPI number that will be released by BLS tomorrow. It is going to be widely watched by both the stock and the bond market. At present, we think the stock market is a lot more scared of inflation than the bond market.
What to look for in the CPI number tomorrow?
January's CPI is expected to comes around 7.2%. It's going to be really surprising for CPI number NOT to have a 7 handle. Today's stock market rally shows that market is expecting it. If the number comes around 7.1% then the stock market is likely to continue to rally. If it comes around 7.4% then it will likely put the brakes on.
How do these small changes in CPI decimals matter?
These CPI numbers, 7.2% etc, are just headline numbers that are calculated year over year. The number is expected to be 7 handle largely because the base CPI (from which it is measured) was really low last year. What economists and markets are really looking for are the month over month numbers.
Right now, the hope of stock market and the belief of bond market is that the inflation is transitory. A 7.2% year over year inflation number currently implies a 4.1% month over month number. Which is a substantial reduction from previous months inflation. It is a big support to the argument that inflation is transitory. Last month's MoM number was 5.75%. Current expectation is 4.1%.
|Headline YoY CPI||Implied MoM Inflation|
One More Thing
Tomorrow's number is likely to be the highest CPI print for the year. We expect later month's headline CPI numbers to be downhill. Month over month the peak occurred in October 2021 as can be seen in the graph above. If tomorrow's number breaks that trend then it will be a big dampener for markets.
What does it mean for rate hikes?
As long as the CPI remains 7.1% to 7.4%, we expect the following:
Fed will remain on course for rate hikes. If there is a big downside surprise (<7%) then the Fed might delay future rate hikes. However, one in March will still go as planned. Also, the expectation for number of rate hikes will come down.
For within range of expectations, there won't be much of a change for the long bonds. The belly of the yield curve will rally a bit if expectation are hit or favorable CPI print. If there is a big downside (favorable) CPI print surprise then expect the belly steepen quickly.
Stock market is going to be sensitive. Currently, it has baked in 7.2% inflation. Today's rally (where many high PE stocks jumped 5%) was in response to CPI expectation moving from 7.3% to 7.2%. This should give a good sense of how it will react tomorrow. For a big downside CPI print surprise expect a big rally. For a high CPI print, expect brakes on and volatility to rise. If expectations are met expect a soft rally to continue.
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