Financial market research and analysis

CPI to confirm easing of behind the curve fears?

US inflation data, as measured by the consumer price index, will be released at 12:30GMT on Tuesday. Expectations are for the CPI to show a 2.2% year on year increase in February, up from 2.1% in January. The month on month figure is expected to fall back to 0.2%, down from 0.5% in January. Meanwhile core inflation, which excludes more volatile items such as food and energy, is forecast to remain constant at 1.8%, with the month on month figure dipping slightly to 0.2% from 0.3%.

Broadly the market is expecting that those prices which soared in January will have returned to more normal levels in February. For example, apparel prices saw an outsized jump in January hitting a 28-year high. In previous years a strong January apparel read has been followed by a significantly weaker February figure. Should this be the case, it would suggest that runaway inflation fears in the previous month could well have been overdone.

More breathing space for the Fed?

Following a strong wage growth element to January’s NFP and a jump in January inflation, there had been growing unease that the Fed was well behind the curve in terms of its inflation outlook. This caused bond yields to soar, the dollar to rally and equity indices to plummet.

Investors will be watching this month’s CPI release carefully to gauge the outlook for the pace of rate rises by the Federal Reserve. However, Friday’s NFP report served to reduce those fears following a disappointing wage growth element to February’s jobs report. Wage growth numbers have shown that the wage gains in the prior months have moderated, with January’s figure even being revised downward, giving the Fed some breathing space.

3 or 4 rate rises?

The CPI, in conjunction with US Retail sales due for release on Wednesday, are unlikely to impact on the Fed’s decision to hike in March. This is considered a forgone conclusion in the eyes of the market, 100% priced in according to the Fed Fund rate. However, the data could impact heavily on the Fed’s plans for rises across the rest of the year. Any signs of inflation slowing down, could put on pause ideas of the Fed hiking 4 times across 2018.

Potential market reaction:

Markets have been demonstrating heightened sensitivity to any signs of prices increasing and higher interest rate expectations.

Strong signs that inflationary pressures are building, with a surprise on the upside for CPI, could cause US treasury yields to push northwards once again, boosting the dollar back towards 90.60 versus a basket of currencies, before extending gains to 91.00. The US stock markets could come under renewed pressure, as investors move towards pricing in 4 hikes.

On the other hand, signs of US inflation deceleration are considered bearish for the dollar and could see the greenback weaken on reduced rate rise hopes back towards 89.00, boosting the US stock markets. The S&P 500 cleared its recent high of 2789 (28^th Feb), a weak CPI reading could see the index extend its gains targeting its previous high of 2877. On the downside support can be seen in the region of 2740.