Just a few days following Friday's strong jobs report by Silicon Valley Bank, Tuesday's February consumer-price index report will bring inflation back to the forefront.
Inflation traders anticipate a 6% increase in headline CPI for February, compared to January's 6.4% readings and December's 6.5%. Even the narrower reading, which strips out volatile food costs and energy costs, could be problematic. This will likely lead to investors having to rely more on non-traditional asset classes. According to Jim Reid and Henry Allen of Deutsche Bank, investors learned that high inflation in the 1970s caused a stagflation crisis in the United States. This was characterized by low growth and sustained price gains.
The picture is further clouded by regional-bank problems, raising concerns about systemic risks, at a moment when the Federal Reserve is more determined in raising interest rates.
Many market participants hope for a more moderate Fed rate hike on March 22, and a more consistent policy path throughout the year. The problems of Silicon Valley Bank 'complicate things by making it really difficult to get a look on financial conditions, and by making policy errors more likely,' stated Derek Tang, an economist with Monetary Policy Analytics, Washington. However, Fed policy makers cannot prevent a financial crisis from occurring when inflation is high. They don't have this luxury.
Tang stated via telephone that while the U.S. economy should be feeling the effects of the rate increases in the past year, it could also be that the rate rises have not been enough to counter stronger and more lasting inflation. He said that if the U.S. finds itself in a 1970s-style period of stagflation then cash and commodities such as iron used for construction would be the best assets to hold.
The uncertainty that a 6%-level CPI reading could bring to financial markets about where the Fed should go with interest rates is what makes the prospect of another 6% level CPI reading so frightening. Although policymakers prefer the PCE index over the less volatile core readings, the annual headline CPI rates is important because it has an impact on household expectations. A higher 6% annual headline CPI reading could theoretically increase the probability of a Fed rate hike by 50 basis points on March 22. The S&P 500 SPX, -1.45% had a nominal return of 6% annually in the 1970s. However, real returns were down by 1% per year according to Deutsche Bank. The bank produced one index that looked at more than 12 developed-market equity and bond percentile valuations. It reached its lowest point since 1800 by 1970.
Financial markets have been bouncing back and forth over the past week between pricing in higher interest rates and gauging the impact of the central bank's rate hikes so far. Friday's policy-sensitive TMUBMUSD02Y 2 year Treasury rate, 4.594% saw its largest one-day drop in 2008, as investors sought the security of government debt. The likelihood of a quarter-point rate increase later in the month, which would reduce the Fed-funds rate target from 4.5% to 4.75% to between 4.75% & 5%, was increased by traders. The most important data for this week is Tuesday's CPI Report for February. Monday's CPI report for February is the most important data. The CPI report will be followed by the NFIB Small Business Optimism Index on Tuesday.
Thursday's data releases include weekly jobless claims and housing starts. They also include building permits and the Philadelphia Fed's manufacturing survey. Friday's data releases include updates on industrial production, capacity utilization and the U.S. Conference Board's U.S. Leading Economic Index and University of Michigan's Consumer-Sentiment Index.