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CPI is the New Payrolls
Forget about Friday's expected weak payroll print. Next week's CPI reading will be the driver of risk from here. Another hot reading puts the Fed in a corner.
In the low inflation world investors have been accustomed to since the GFC, the first Friday of the month’s Non-Farm Payroll release has acted as a key signpost for markets, often giving investors direction regarding both the growth trajectory of the US economy and any potential upcoming changes in the Fed’s monetary policy. In this low inflation world, momentum toward achieving maximum employment was the really the only thing that could kick off a Fed tightening cycle so these monthly data releases became paramount to investors’ understanding regarding the next move for Fed.
Today’s environment is quite different. We no longer live in a low inflation world. The idea that high inflation readings in 2021 would be “transitory” has been thrown out the window. We continue to get inflation readings that are persistently above the Fed’s 2% inflation target. While we still have many structural deflationary factors in place including demographic trends, technological innovation and debt dynamics, Covid has brought forward some inflationary trends as well which are putting up a fierce battle with these deflationary forces. We continue to have supply chain issues due to the pandemic which are not easily fixable, ESG/climate change policies are starving capital from traditional energy sources, leading to higher energy prices, and heightened geopolitical tensions are back too, which are keeping upward pressure on most commodity prices. Furthermore, and perhaps most importantly, Covid has helped tighten the labor market, in part due to many workers with health concerns struggling to re-enter the labor market but also due to the retirement trends of older workers who are exiting the workforce after sizable net worth gains realized from their stock portfolios and real estate holdings post the massive money printing we have witnessed. We are at maximum employment already for this cycle. This tightness has kicked off the beginning of a higher wage cycle which policymakers are watching closely to make sure a wage/price spiral doesn’t begin to get out of control.
So that is why next week’s CPI reading is of paramount importance and will help investors trade for the next several weeks. After last month’s 7% CPI and 5.5% core CPI, forecasters are now looking for a 7.3% reading and 5.9% core CPI reading for January, sequentially higher month on month. After today’s ISM prices paid reading re-accelerated in January vs. December and with oil prices making new highs, pricing pressures remain top of mind and are becoming harder for the Fed to deal with just words alone. We think another strong reading will put the Fed into a corner. While investors have begun to price in more rate hikes for 2022 since the beginning of the year, we have observed inflation breakeven yields which have begun to rise again off the lows from 10 days in line with some recent stock market strength as investors are looking at the recent bit of weaker growth data as potential reasons for the Fed to go slower. But with inflation readings remaining hot, we think that will be very difficult. We suspect another hot CPI print next week can become a catalyst for another bout of risk off market behavior as investors price back in the need for a more aggressive Fed. And as we have discussed, a more aggressive tightening Fed, especially into a slower growth environment, is not a favorable backdrop for risk assets.
So forget about the potentially weak payroll print this Friday acting as a reason for the Fed to go slower because of a growth concern. We instead think all eyes should be on next week’s CPI release as reason for them to plow full steam ahead with their tightening agenda to prevent inflation expectations from running away.
*Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do you own due diligence.