Stock investors brace for possibly the ‘most important inflation reading in recent memory’
Investors and traders are on edge about what Wednesday’s consumer-price index for December might say about the direction of inflation — data that could potentially move the stock and bond markets in a pretty big way.
The stakes are high because investors are exposed to surprises in either direction from the CPI report. The annual headline CPI inflation rate — which fell for six straight months from April to September 2024 — is now anticipated to edge back up for a third straight month, to 2.9% from 2.7% in November, based on the median estimate of economists polled by the Wall Street Journal. Expectations are for this annual headline rate to approach 3% for the first time since July, a few months before the Federal Reserve delivered the first of its three 2024 rate cuts.
An annual headline CPI rate that comes in above 2.9% would shock investors. But the details of the report matter as much as this figure, if not more.
If Wednesday’s data contains strong numbers, it could further cement the idea that there will be no Fed rate cuts in 2025 and may even give rise to the possibility of a hike, whereas weak readings might help calm market investors’ fears, according to Chris Brigati, chief investment officer of Texas-based investment firm SWBC. Brigati, whose firm manages more than $1 billion in assets, said the December CPI report “may be the most important inflation reading in recent memory.”
Michael Reynolds, vice president of investment strategy at Glenmede in Philadelphia, which manages roughly $47 billion in assets, said he’s strongly focused on the monthly core reading — particularly what’s known as core services excluding shelter — because it’s a sticky part of inflation that’s tough to bring down. He believes a 0.5% level on monthly core CPI, above economists’ median estimate of 0.3%, would be enough to upset the stock and bond markets.
“Any sign of a reacceleration in inflation is going to cause investors to re-evaluate what an appropriate yield is on Treasury securities, which could put upward pressure on those yields,” he said via phone. The equity market is increasingly sensitive to Treasury yields, he noted, “so we could see a re-evaluation of the appropriate valuation levels on equities.”
Reynolds said the process of re-evaluation could last “until confidence is reanchored at a reasonable range around 2%” for inflation. He added that a 10-year yield of 5% is possible, depending on how meaningful any acceleration in CPI inflation turns out to be. In addition, traders would continue to pull back on their expectations for further easing by the central bank, with fed-funds futures “less likely to continue flirting with that second rate cut for 2025 if inflation becomes a problem.”
Already some big-name firms, such as Barclays UK:BARC, have thrown out the possibility that CPI could stall at around 3% if President-elect Donald Trump’s proposed tariffs become reality. Michael Landsberg, chief investment officer at Florida-based Landsberg Bennett Private Wealth Management, goes even further: He said his firm, which has around $1 billion in assets under management, thinks CPI inflation is likely to rise to between 3.5% and 4% this year.
And at TD Securities TD, strategists Robert Both, Andrew Kelvin and Chris Whelan said: “The possibility of hikes in the U.S. has entered the conversation. We don’t see it as a material possibility, but it does reflect sentiment and where [we] are at in the current regime.”
Tuesday’s tamer-than-expected reading of the producer-price index for December offered investors and traders a bit of a reprieve from the string of elevated inflation figures seen in the final months of last year. But it wasn’t enough to sway the view of Glenmede’s Reynolds about Wednesday’s inflation report because producer prices are “a pipeline of where CPI may be going, rather than where it has been,” and gives insights into future months, he said.
On Tuesday, U.S. stocks DJIA SPX COMP finished mostly higher as investors and traders assessed the impact of the December PPI report . The 30-year yield BX:TMUBMUSD30Y briefly broke above 5% and finished near its highest closing level since Oct. 31, 2023. Meanwhile, 5- and 10-year breakeven rates, which are market-based expectations of future inflation, jumped to almost 2.6% and 2.5%, respectively, according to FactSet data — moving further away from the Fed’s 2% target.
There are a few other worrisome signs about inflation expectations. A December survey of consumers from the New York Fed showed that median expectations for inflation over the next three years increased to 3% from 2.6%. And data from the University of Michigan revealed that consumer expectations for inflation over the next year rose to 3.3% in January.
Separately, inflation traders are currently bracing for the annual headline CPI rate to come in at 2.9% for both December and January. They expect the rate to slip toward 2.5% through May before rebounding to 2.8% in August and September.
If Wednesday’s CPI data comes in hotter than expected, “the market psychology will be that things will only get worse,” said Gang Hu, a trader at New York hedge fund WinShore Capital Partners. But if the data comes in at or below expectations, he said, “that doesn’t mean much.” Market participants are looking at this report “with an asymmetric view, meaning that if the numbers are low, they can write it off, but if they are high, it will only get worse.”