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With the sharp rise in interest rates, markets have been on the lookout for inflation.
Thus, the December CPI report from Wednesday is important, even though it still shows a subdued rise in the consumer price index. According to the Dow Jones, economists expect an increase of 0.4% month-on-month and 1.3% year-on-year. The expected core CPI, less food and energy, is expected to rise by 0.1% or 1.6% year-on-year, compared to 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 ten-year break-even period, an instrument for the bond market for inflation expectations, was 2.07% on Tuesday, indicating that investors expect inflation to be the next ten years. It was as high as 2.11% last week.
“I do think inflation is a real changer if it were to happen. That’s definitely why rates are rising,” Doubleline Capital CEO Jeff Gundlach told CNBC this week. He said he expects the CPI to reach 3% by May or June.
Covid-19 has had a unique impact on inflation. Prices fell sharply when the economy closed last year, and the economy and prices were uneven. Rents, for example, have fallen sharply, but house prices are rising. Strategists said that prices of the service sector were suppressed, but the price of goods was rising.
‘Once you get to March, April, May, you will easily get comparisons. You will see inflation of 3%, ‘says Peter Boockvar, chief investment officer of Bleakley Advisory Group. “I think the pressure is increasing, and that’s going to be the key story for 2021.”
Rising interest rates have already caused a chill by some Big Tech and growth stocks, 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 increase as the economy reopens and as the government stimulates funds to work through the economy.
Since the beginning of January, the 10-year Treasury yield has climbed by almost 25 basis points, to as high as 1.18% on Tuesday, before falling back to 1.14%. “I think we are not prepared to have a large inflation rate tomorrow,” said Chris Rupkey, chief financial officer of MUFG. “Inflation is supposed to rise a bit, but it’s basically that petrol prices have risen at the pump … Whatever inflation is, it’s likely to be strictly energy-related, and the Fed chairman [Jerome] Powell said they were not going to respond. ‘
Rupkey said there could also be some commodity inflation, which results in consumers getting home delivery instead of going shopping.
Frustrated by a 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 will not change policy unless it continues at a higher rate.
“Somehow, inflation has been put under pressure from Fed concerns. They’ve all become a major indicator as an important indicator,” Rupkey said. Tariff strategists said the market is already full of speculation that, although it may be far into the future, inflation could rise and eventually encourage the Fed to shift its own target rate with zero fed funds.
“I think the market is struggling similarly with the potential negative of higher rates on the one hand, and what it can do to compress multiples, but on the other hand, to tell themselves that rates are rising because we have the vaccination, and therefore remain positive on risk assets, “said Boockvar.” It’s like a tug of war. “
“I think inflation is the worst nightmare of inflated asset prices … for high multiple stocks, inflation is not their friend,” he said.
The American president of St. Louis, James Bullard, acknowledged on Tuesday that prices should rise later this year. “It looks like inflation will move higher amid rising price pressure expectations,” he said in an interview, noting that he expects more inflation in 2021 and 2022.
“I will reiterate my conviction that the Fed will eventually get the inflation they have longed for and then some, despite their policies, and they will eventually regret what they wanted, as well as the bond market and anything that is priced.” said Boockvar.
The CPI report will be released at 08:30 ET.