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Thursday’s Cpi Report has the Potential to Extinguish Investors’ Expectations that Inflation will soon Dissipate, Sending Ripples Through the U.S. Stock Market in Its Wake

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The financial markets’ optimism that inflation has already peaked provides very little margin for error, according to Michael J. Kramer of Mott Capital Management.

Investors eagerly await the December Consumer Price Index (CPI) report from the Bureau of Labor Statistics on Thursday, which could have a decisive role in determining the size and frequency of future Federal Reserve interest rate hikes. Analysts initially forecasted that December’s CPI reading would show a 6.5% rise from last year, slowing from the 7.1% recorded in November. The core price measure, which accounts for volatile food and fuel costs, is projected to increase 0.3% from November’s figures or 5.7% over the course of a year.

The CPI is set to be particularly influential for the Fed’s upcoming policy meetings, with analysts at Pimco anticipating that by February 1st, inflation and labor market data will have moderated enough for the central bank to pause its rate hikes before its May meeting. As such, they expect Fed funds rates to reach 5% in mid-year following two 25 basis point increases — one in early February and one in March — after the 50 basis point increase at December’s meeting.

However, this leaves little room for error, as Michael J Kramer of Mott Capital Management noted on Monday. Suppose higher-than-expected figures are found in this week’s CPI report. In that case, it could put paid to investors’ optimism that inflation is finally peaking and could lead to a dramatic shift away from this belief, as seen through market-based inflation expectations.

According to Rhys Williams, the chief strategist at Spouting Rock Asset Management, December’s core inflation is projected to rise by a noteworthy 5%. According to him, the U.S. stocks commenced a marginal rally in early 2023 due to optimism that cooling inflation and impending recession could persuade the Fed into moderating their interest rate hikes; yet, this surge may dissolve swiftly if December’s CPI appears too elevated for comfort.

Despite two consecutive months of lower-than-expected readings giving hope that inflation was stabilizing, many analysts remain cautious about predicting an improvement any time soon, given global economic conditions and lengthy delays returning supply chains back up to full capacity post-pandemic disruption. With U.S Treasury yields continuing their climb, it is all still dependent on whether recent low readings can be maintained going forward.

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