Analysts have been ramping up their inflation expectations and not even one of them in Bloomberg economists’ survey had forecast a headline CPI print of below 7% ahead of the much-anticipated release today. You can understand why: expectations were beaten in 8 out of the past 10 occasions. As far as the latest inflation report for the month of January is concerned, well, they were right not to expect a sharp drop in price pressures. CPI has once again surprised to the upside, with prices accelerating for the fifth consecutive month.
CPI jumps to 7.5% annual pace
- Headline CPI printed +0.6% month-over-month or 7.5% year-over-year, compared with expectations of 0.5% and 7.3%, respectively. In December, CPI had risen 0.5% on the month and 7.0% on a year-over-year basis.
- Core CPI came in at +0.6% m/m and 6.0% y/y, versus expectations of 0.5% and 5.9%. In December, core CPI had risen 0.6% m/m and 5.5% y/y.
Markets react
The initial reaction of the market has been a swift one. As you would have expected, the dollar and bond yields rose, causing gold and Nasdaq futures to drop
What does it all mean for monetary policy?
The latest inflation figures come after prices consistently surprised to the upside throughout 2021. Alarm bells were raised when inflation climbed to 7.0% in December, raising speculation that the Fed would hasten its rate hiking cycle, with the Fed Chair Jerome Powell subsequently indicating that all FOMC meetings were live and refusing to rule out a 0.5% hike in March. Bets over a lager rate hike for the March meeting rose following an unexpectedly strong January non-farm payrolls report, which, along with the jump in wages, easily beat expectations.
Prior to today’s inflation report, bets had risen to one-in-three chance of a 50-basis-point hike, which would be the first since 2000. Well, you can safely assume that those bets have been ramped up even further now.
For what it is worth, I don’t think we will see the Fed hiking by half a percentage point, but today’s 7.5% CPI print does put a lot of pressure on the Fed to walk the walk in terms of tightening, having done the talking. I think 5 rate increases for 2022 is a real possibility now.
Small caps could fall further out of favour
Small caps have significantly underperformed large caps, mainly due to the impact of a sudden rise in bond yields. Investors in small caps have become concerned that funding will cost more for smaller companies, which tend to rely more on borrowing than on issuing new equity to raise capital. In other words, they rely more on debt to fund operations. As debt costs increase, this is bad news for stocks in general, but more so far smaller companies.
Russell testing major resistance
Source: ThinkMarkets and TradingView.com
The small-cap Russell 2000 index is re-testing the underside of the broken support zone in the 2085-2123 region, as per the chart below. If resistance holds here, watch out for fresh weakness for this index, and potentially the Nasdaq 100.
