US CPI Report Next Week: Investors expect higher inflation against the backdrop of Powell’s new favorite word ‘disinflation’

By José Torres

Markets closed with the first weekly loss after experiencing two consecutive weeks of impressive gains. As markets decline, investors are looking ahead to next week’s Consumer Price Index (CPI) while marking their calendars with a red heart for Valentine’s Day.

The recent revision in the updated version of the estimated CPI index for December shows prices rose rather than declined and is adding to angst among investors who are struggling with a hawkish Fed that appears to have minimal tolerance for inflation. November’s CPI was also revised higher while higher inflation expectations from the University of Michigan’s Consumer Sentiment report released later this morning are also adding to that angst.

Indecisive market action with a downside bias continues.

Bond yields are currently a mixed bag, roughly unchanged at the short-end but 3-5 basis points (bps) higher on the long-end. The dollar index is catching a bid, up 0.3% as investors anticipate what is likely to be an unacceptably high CPI report next week against the backdrop of Chairman Powell’s new favorite word: “disinflation.”

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Since his two recent public appearances in which he said inflation is slowing but still troublesome, Federal Open Market Committee members have expressed a much more hawkish tone, echoing the “higher for longer” mantra.

Consumer sentiment rose to 66.4 in February, marking three-consecutive monthly gains while remaining at 22% below its 45-year historic average. February’s 66.4 reading was higher than last month’s 64.9 and beat expectations for 65. While five-year inflation expectations remained subdued at 2.9%, unchanged from last month, one-year inflation expectations rose from 3.9% to 4.2%.

Finally, consumers responded favorably when asked about current economic conditions with a rate of 72.6, showing progress from last month’s 68.4, but their expectations about the future reflected the opposite sentiment, falling modestly from 62.7 to 62.3 during the period.

The year-to-date market rally illustrates that investors have downplayed Fed comments that the risk of not completing the battle against inflation is more severe than the potential risks associated with continuing monetary policy tightening.

The recent trifecta of data consisting of last week’s unexpectedly fiery jobs report, recent strengthening consumer sentiment report and the upward revision to the last two CPIs is likely to bring an answer to that question.

If investors take the Fed’s outlook seriously as corporate guidance continues to paint a bleak outlook for 2023, Super Bowl Sunday may lead to a Valentine’s week selloff. Of course, only time will tell but at a bare minimum, the data pointing to continued inflation and weakening corporate revenues is likely to create a rocky road in the coming weeks.

(Author is Senior Economist at Interactive Brokers)