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With the sharp rise in interest rates, the markets were attentive to rising inflation.
So Wednesday’s December CPI report will be important, even if it still shows a slight increase 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 CPI core, less food and energy, is expected to increase 0.1% or 1.6% year on year, against 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 breakeven point, a bond market instrument for inflation expectations, was 2.07% on Tuesday, suggesting that investors expect inflation to reach that average over the next 10 years. It was 2.11% last week.
“I think inflation is a real game changer if it does. That is certainly why rates are going up,” Jeff Gundlach, CEO of Doubleline Capital, told CNBC this week. He said he expects the CPI to reach 3% in May or June.
Covid-19 had a unique impact on inflation. Prices fell sharply when the economy closed last year, and there was an uneven impact on the economy and prices. Rents, for example, have fallen sharply, but house prices are rising. Strategists said that while prices in the service sector are depressed, prices of goods are rising.
“Once you get to March, April, May, you’ll start getting easy comparisons. You’ll see inflation of 3%,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “I think the pressures are increasing and that will be the main story for 2021.”
The rise in interest rates has already caused a chill in some Big Tech stocks and growth, so the stock market may be sensitive to any increase in inflation. One factor behind the rise in yields is the expectation that inflation will rise as the economy reopens and government stimulus funds work through the economy.
Since the beginning of January, the 10-year Treasury yield has risen by almost 25 basis points, reaching 1.18% on Tuesday, before dropping to 1.14%. “I think we are not prepared for a large number of inflation tomorrow,” said Chris Rupkey, chief financial economist at MUFG. “Inflation must have gone up a bit, but basically the prices of gasoline at the pump have gone up. … Whatever the inflation, it is likely to be strictly related to energy, and Fed chairman [Jerome] Powell said that they will not respond. “
Rupkey said there may also be some product inflation, resulting from consumers receiving home deliveries instead of in-store purchases.
Frustrated by the lack of inflation for years, the Fed has changed its inflation policy so that it now targets an average range instead of its 2% target. This means that inflation could rise above the 2% level, but the Fed would not change the policy unless it persisted at a higher rate.
“In some way, inflation has been put on the back burner in the Fed’s concerns. They have all moved to full employment as a key indicator,” said Rupkey. Rate strategists said the market is already full of speculation that, although in the distant future, a burst of inflation could raise rates and ultimately lead the Fed to move its own zero-rate target to fed funds. .
“I think the market is struggling with the negative potential of higher rates, on the one hand, and what it can do to compress multiples, but on the other hand, it tells itself that rates are going up because we have the launch of vaccine, and therefore remain positive about risky assets, “said Boockvar. “It’s like a tug of war.”
“I think inflation is the worst nightmare of inflated asset prices … for bullish multiple stocks, inflation is not their friend,” he said.
St. Louis Fed President James Bullard acknowledged on Tuesday that prices are expected to rise later this year. “Inflation looks set to rise amid rising expectations of price pressure,” he said in an interview, noting that he expects more inflation in 2021 and 2022.
“I will repeat once again my belief that the Fed will finally get the inflation it so longs for and more, despite its policies, and they will end up repenting what they want, as well as the bond market and anything with a lower price “said Boockvar.
The CPI report will be released at 8:30 am Eastern time.