With rates on the rise, investors fearing any signs of inflation

With the sharp rise in interest rates, the markets have been on the lookout for rising inflation.

So Wednesday’s December CPI report will be important even if it still shows a moderate rise in the consumer price index. According to Dow Jones, economists expect an increase of 0.4% month over month and 1.3% year over year. The core CPI, less food and energy, is expected to rise 0.1% or 1.6% year over year, from 0.2% and 1.6% in November.

The rapid rise in bond yields since the start of the year has been accompanied by rising inflation expectations. The 10-year breakeven, a bond market instrument for inflation expectations, stood at 2.07% on Tuesday, suggesting that investors expect inflation to reach this average level for the next 10 years. It was as high as 2.11% last week.

“I think inflation is a real game changer if it happens. That’s definitely why rates are going up,” Jeff Gundlach, CEO of Doubleline Capital, told CNBC this week. He said he expects the CPI to hit 3% by May or June.

Covid-19 has had a unique impact on inflation. Prices fell sharply when the economy shut down last year, and there was an uneven impact on the economy and prices. Rents, for example, have fallen sharply, but house prices are rising. The strategists said that if the prices of the service sector are depressed, the prices of goods rise.

“Once you get in March, April, and May, you’ll start making easy comparisons. You will see inflation of 3%, ”said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “I think the pressures are increasing, and that will be the key story for 2021.”

Rising interest rates have already sent shivers down some big tech and growth stocks, so the stock market could be sensitive to any pick-up in inflation. One of the factors driving the rise in yields is the expectation that inflation will accelerate as the economy reopens and government stimulus funds work into the economy.

Since the start of January, the yield on 10-year Treasury bills has climbed nearly 25 basis points to 1.18% on Tuesday before falling back to 1.14%. “I guess we’re not prepared for a lot of inflation tomorrow,” said Chris Rupkey, chief financial economist at MUFG. “Inflation is supposed to rise a bit, but it is essentially gasoline prices at the pump that have gone up. … Whatever inflation is, it is likely to be strictly energy related. , and the president of the Fed [Jerome] Powell said they weren’t going to answer. “

Rupkey said there could also be commodity inflation, resulting in consumers having delivery to their homes instead of shopping in stores.

Frustrated by a lack of inflation for years, the Fed changed its inflation policy so that it now targets an average range instead of its 2% target. This means that inflation could exceed that 2% level, but the Fed would not change its policy unless it persists at a higher rate.

“Somehow, inflation has been put on hold from the Fed’s concerns. They’ve all moved on to full employment as a key indicator,” Rupkey said. Rate strategists said the market was already full of speculation that, although far into the future, a surge in inflation could push rates up and ultimately prompt the Fed to move its own target federal funds rate to zero. .

“I think the market is sort of grappling with the negative potential of higher rates on the one hand, and what that can do to compress multiples, but on the other hand, thinking that rates are going up because we have the vaccine rollout, so stay positive on risky assets, “Boockvar said.” It’s like tug of war. “

“I think inflation is the inflated asset price’s worst nightmare… for high multiple stocks, inflation is not their friend,” he said.

St. Louis Fed Chairman James Bullard acknowledged on Tuesday that prices are expected to rise later this year. “Inflation is expected to rise amid rising price pressure expectations,” he said in an interview, noting that he expects inflation to rise in 2021 and 2022.

“I will repeat my belief that the Fed will finally get the inflation it aspired to and then some, despite their policies, and they will end up regretting what they wished for, just like the bond market and everything that has one. price, ”said Boockvar.

The IPC report will be released at 8:30 a.m. ET.