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With the sharp rise in interest rates, the markets were looking for rising inflation.
So Wednesday’s December CPI report will be important, even if it still shows moderate rise in the consumer price index. According to Dow Jones, economists expect an increase of 0.4% month on month and 1.3% year on year. The core CPI, less food and energy, is expected to increase by 0.1% or 1.6% year-on-year from 0.2% and 1.6% in November.
The rapid rise in bond yields since the beginning of the year has been accompanied by rising inflation expectations. The 10-year break-even, a bond market instrument for inflation expectations, was 2.07% Tuesday, suggesting investors expect inflation to average at that level for the next 10 years. Last week it was even 2.11%.
“I really think inflation is a real game changer when it occurs. That’s certainly why rates are going up,” Jeff Gundlach, CEO of Doubleline Capital said on CNBC this week. He said he expects the CPI to reach 3% in May or June.
Covid-19 has had a unique impact on inflation. Prices fell sharply when the economy stopped last year, and there is an uneven impact on the economy and prices. Rents, for example, have fallen sharply, but house prices are rising. Streets said that while services prices are low, commodity prices are rising.
“Once you get to March, April, May, you start to have easy comparisons. You see an inflation rate of 3%,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “I think the pressure is mounting, and that’s going to be the most important story for 2021.”
Rising interest rates have already caused a chill on some Big Tech and growth stocks, so the stock market could be sensitive to any inflation recovery. One factor behind the rise in revenues is the expectation that inflation will pick up as the economy reopens and government stimulus funds work through the economy.
Since the beginning of January, the yield on 10-year Treasury bonds has risen nearly 25 basis points, to 1.18% Tuesday, before falling to 1.14%. “I don’t think we are prepared for a big inflation figure tomorrow,” said Chris Rupkey, chief financial economist at MUFG. “Inflation should have gone up a bit, but it is actually gasoline prices at the pump that went up.… Whatever inflation there is, it is probably strictly energy related, and the Fed chairman [Jerome] Powell said they will not respond. ‘
Rupkey said there could also be some commodity inflation, as a result of consumers getting home delivery instead of shopping in stores.
Frustrated by a lack of inflation for years, the Fed changed its inflation policy to target an average bandwidth instead of the 2% target. That means that inflation could rise above that 2% level, but the Fed would not change policy unless it persisted at a faster pace.
“Somehow inflation has been put on the backburner of Fed concerns. They have all moved to full employment as a key indicator,” Rupkey said. Stock strategists said the market is already full of speculation that, although far into the future, an inflation spike could push up interest rates and eventually prompt the Fed to change its own zero-fed funds target rate.
“ I think the market is struggling a bit with the potential negative effect of higher rates on the one hand, and what that can do to reduce multiples, but on the other hand they say rates are going up because we have the introduction of the vaccine, and therefore remain positive on risky assets, ”said Boockvar. “It’s like a tug of war.”
“I think inflation is the worst nightmare of inflated asset prices… for high stocks, inflation is not their friend,” he said.
St. Louis Fed president James Bullard on Tuesday acknowledged that prices should rise later this year. “Inflation looks set to get higher despite rising price pressure expectations,” he said in an interview, noting that he expects more inflation in 2021 and 2022.
“I will reiterate my belief that the Fed will finally get the inflation they craved and a few more, despite their policies, and eventually they will regret what they were looking for, just like the bond market and everything priced off it , ‘said Boockvar.
The CPI report will be released at 8:30 a.m. ET.