U.S. stock-market investors are looking ahead to Valentine’s Day, but not just because their hearts are filled with love.
Feb. 14, this coming Wednesday, is seen as a critical day for Wall Street because it will provide further illumination on perhaps the biggest bogeyman stalking the major indexes: inflation.
The recent turbulence in stocks — which resulted in major indexes suffering their biggest one-week percentage decline in about two years last week, pushing the Dow DJIA, +1.70% and S&P 500 SPX, +1.39% into correction territory — was largely sparked by the January jobs report, which showed a higher-than-expected acceleration in wage growth. That raised the question of whether investors should expect inflation to come back to the economy after years of being dormant, and whether that in turn would lead the Federal Reserve to be more aggressive in raising interest rates in an attempt to avoid the economy overheating.
Recent trading — which has included a sizable recovery off the market’s lows — has largely been driven around whether inflation fears have been overblown, or whether the move lower was justified by the changing macroeconomic environment. Volatility has remained elevated, as thus far the wage-growth figure is one of the few bits of hard data that investors have had to go on about this issue.
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That changes on Wednesday, which will see the release of the January consumer price index, a closely watched gauge of inflation that will be more closely watched than usual this week. Another reading will come the subsequent day, with the Thursday release of the producer price index, also for January.
“There are several big tests coming up for markets, but the two inflation metrics are going to take a disproportionate share of the attention this week, in light of what’s happened over the past fortnight” since the wage data was released, said Phil Orlando, chief equity market strategist at Federated Investors.
This view was echoed by UBS analysts, who wrote that the report “takes on additional importance” given how inflation concerns have been driving trading.
“It seems to me that people are now viewing the world a little differently” after the wage figure, said Larry Hatheway, chief economist at GAM Holding AG. “People could be saying, ‘maybe I’ll wait until I see the CPI numbers before I buy the dip.’ The data is a number that we haven’t had in play for some time.”
Hatheway spoke to MarketWatch last week, prior to the two-day rally in the stock market.
The CPI figure is expected to show growth of 0.4%, an acceleration from the previous reading of 0.1%, according to the mean estimate of analysts polled by MarketWatch. Core CPI is seen up 0.2%, compared with the December reading of 0.3%. The forecast for PPI is that it will show growth of 0.4%. Typically the Fed looks for inflation around 2%, but it has missed this target for six straight years. The yearly pace for CPI was about 2.1% at the end of 2017.
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Orlando said the recent selling in equities wasn’t justified when considering the inflation picture, although he said it was “extraordinarily healthy” from a technical perspective. He also stressed that if the CPI and PPI reports came in aligned with expectations, that would be a positive for markets, even if there was a kneejerk move lower in the major indexes.
“The fears about inflation were unwarranted. Why would the Fed be concerned about spiking inflation when it is still below where it wants to see it? It won’t take the Fed-funds rate up to fight a problem that doesn’t exist,” Orlando said.
Even if the reports came in sharply ahead of expectations, he urged perspective. “That wouldn’t be a reason to sell,” he said. “We’d want some additional information, and I’d love to see [Fed Chair Jerome] Powell discuss whether it was influencing his thought process, but there’s nothing wrong with market fundamentals, and inflation is where it should be given our levels of growth.”
In one sign that the potential for inflation may have been overstated by the wage-growth figure, a New York Fed survey showed that consumer expectations for inflation declined in January.
“Inflation should always be on an investor’s mind, like someone who has high blood pressure. If we see higher-than-expected inflation in this week’s data, that will add to the current environment of higher volatility,” said Michael Loewengart, director of investment strategy at E-Trade Financial.
“However,” he added, “the record-low volatility that we had been seeing was unsustainable, and any single datapoint shouldn’t be used as a reason to make wholesale changes to one’s portfolio.”