How Will the Market React to CPI?

#OPINIONLEADER#

There’s a lot been said about the US potentially hitting “peak inflation,” but it not all about today’s CPI print…

Well, it obviously depends on the data, doesn’t it? But it is not all about today’s CPI print and the immediate reaction to the data won’t necessarily be a precursor for future trends in the markets.

Anyway, headline CPI is seen cooling to 8.1% year-over-year in April from 8.5% previously, with core CPI expected to print 6.0% compared to 6.5% in March. On a month-over-over-month basis, headline and core CPI estimates are expected to print 0.2% and 0.4% respectively.

Peak inflation

There’s a lot been said about the US potentially hitting “peak inflation,” which may explain why traders have taken their feet off the gas in the last couple of days, allowing equity indices and government bond prices to stabilise a little, while the dollar has cooled off a tad.

There are 3 main considerations to take into account after the CPI data is released.

• First, the possibility of inflation coming in slightly weaker today may increase those “peak inflation” talks, which is why traders are taking no chances ahead of the publication of the data. A weaker CPI print may lead to some strength in downbeat tech stocks and gold, and weigh on the dollar. However, will one month’s worth of data matter? As I mentioned, it may do in the eyes of short-term traders, so we may well see a sharp reaction if the data does come in weaker than expected.
• Second, what about beyond the short-term reaction to any weakness in CPI? I reckon investors will then wonder how quickly inflation will fall back towards more normal levels. There are no major leading indicators to suggest it will fall very quickly. If anything, we may see inflation remaining elevated for a long period of time instead. So, at best, the hope is that it will start to cool off slowly, due above all to the base effect, but prices won’t go down fast or much. Against this backdrop, I wouldn’t expect to see a major improvement in risk appetite. Indeed, we may even see a
• Third, let’s not forget that there is a risk that instead of weakening price pressures, CPI will come in hotter. If that’s the case, all those “peak inflation” hopes will be dashed, and we could see a sharp sell-off in stocks and other risk assets as the dollar and bond yields resume higher.

All told, I don’t expect to see a major reversal in the trends today. As such, I maintain a moderately bearish outlook towards equities due to central bank tightening, neutral towards gold and silver, and slightly bullish on the dollar.

EUR/USD stuck between a hard place and rock

Above, I wrote ‘slightly’ bullish on the dollar because much of the Fed’s future tightening is already priced in. But with some of the other major central banks, including the ECB, not so keen to tighten its belt fast or very tightly, and given the ongoing Ukraine situation the outlook weighing on economic activity in Europe, the EUR/USD remains bearish for now.