Financial markets are counting on consumer-price inflation to fall below 3% for first time since 2021



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Tuesday has the potential to bring investors something they haven’t seen in almost three years: A U.S. inflation rate based on the consumer-price index that looks more like 2%.

In the run-up to January’s CPI data, stocks continued to hover near records as of Monday afternoon, with the S&P 500 index
SPX
still above 5,000 — helped by growing confidence that inflation is improving. Treasury yields were little changed, following a steep climb over the past few weeks that’s been driven by stronger-than-expected U.S. economic data.

Economists now expect an annual headline CPI rate of 2.9% for January, which would be the lowest level since March 2021 and down from 3.4% in December. Any upside surprise in Tuesday’s report that shows inflation remaining unexpectedly sticky, however, is likely to shake up the bond market the most, according to analysts.

Read: The first big inflation report of 2024 is coming out. Here’s what the CPI is likely to show.

Tuesday’s data is likely to “just confirm what the market already knows: that inflation is falling,” said Adam Turnquist, chief technical strategist for LPL Financial in Green Bay, Wis. “Anything outside of that is going to lead to some volatility on a short-term basis, but it’s also not going to detract from investors’ confidence on inflation.”

“Stocks should do well if inflation is in line or below expectations and, in the event that it isn’t, investors might be willing to withhold judgment by focusing on individual components of the report that are expected to fall, like shelter,” Turnquist said via phone. “Fixed income will be moving the most if inflation comes in hotter than expected, following a string of upside surprises to the economy. If you throw in a high inflation print, that’s going to add to the upside we’ve seen in terms of yields. And the dollar is highly correlated to the 10-year rate.”

Treasury yields ended Friday with their biggest weekly advances in three weeks, after minor revisions were made to past CPI reports.

Two –
BX:TMUBMUSD02Y
and 10-year rates
BX:TMUBMUSD10Y
were not far from their highest levels since mid-December on Monday, while the ICE U.S. Dollar Index
DXY
has climbed roughly 1.8% for the year. All three major U.S. stock indexes were mixed in afternoon trading, with the S&P 500 paring back on its earlier gain to trade around 5,022 and the Dow Jones Industrial Average up more than 100 points, or 0.4%.

“Stocks are pricing in a baseline expectation that inflation is largely improving, and it’s now more about monetary policy and when — not if — the Fed is going to cut rates and by how much,” Turnquist said. “The inflation hysteria around these prints has deteriorated.”

The annual headline rate of CPI reached a peak of 9.1% in June 2022 and has since steadily fallen, holding around 3% for seven straight months. While Federal Reserve policymakers prefer to rely on another gauge known as the PCE and the core readings that exclude food and energy, officials also pay attention to annual headline CPI because of its ability to affect household expectations.

See also: Why Americans Are So Down on a Strong Economy

“Anything under 3% offers some sort of assurance,” said strategist Will Compernolle at FHN Financial in New York. “But I think tomorrow won’t give as much as definitive clarity on inflation as the markets hope for.”

“January was full of disruptions, with weather and illness. Consumer spending patterns changed and companies couldn’t operate at full capacity. How those two ingredients combine, I’m not sure,” Compernolle said via phone. “But with lower demand, inflation could look cooler, on net, and January’s data may not be representative of the longer-term trajectory on inflation.”

The report “will probably be seen as ‘good enough,’ and might provide a sense of relief that inflation is not moving any faster,” he said on Monday.



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