Inflation Base Effects
Macro Perspectives
We get the January inflation report today - these have been huge events for the stock market;
For four consecutive months (Sept - Dec), the inflation report induced a trading range in stocks, on the day, of about 5% (on average).
It was the inflation report on October 13th, that marked the low of the bear market in stocks.
Arguably, it was the weak inflation report on January 12th that cleared the way for the break above the 200-day moving average, and the break of the big technical downtrend in stocks (chart below).
Of course, the reaction in stocks is predicated on what the inflation arc means for Fed policy. So, what should we expect?
The bad news: The monthly change in prices is expected to be the hottest in four months.
The good news: The market will likely ignore it, for a couple of reasons...
Reason #1: Expect the market to focus on the year-over-year number.
You can see in the chart, inflation over the past seven months, on this headline index, has already leveled off - the rate-of-change in prices (inflation) has clearly been curtailed.
Even if today's report shows that inflation in the month of January was hotter than the past few months, when measured against the base of twelve months ago, the headline inflation number the media will tout will still show a decline ("inflation moving in the right direction" - lower).
That said, even if the monthly number is surprisingly weak, the headline year-over-year number will still be a big number, relative to the inflation that the Fed is targeting (2%).
Bottom line, the year-over-year headline inflation is still likely running around 6%. And, it will continue to measure at historically high levels in the months ahead, regardless of what's really happening with current inflation. Why? Base effects. Because of the aggressive rate-of-change in prices twelve months ago, the most recent CPI Index reading will continue to be measured against a very low base.
Reason #2 (that the market will likely ignore a hot monthly inflation number): The Fed's favored inflation gauge is core PCE - the effective Fed Funds Rate is now above core PCE.
And as the Fed has reminded us, the inflation storms of the past have only been quelled when interest rates are taken ABOVE the rate of inflation. Not only are they there, but they've built in expectations that they will do a couple more rate hikes, for good measure.
The hawkish expectation setting by the Fed, should reduce (if not eliminate) the potential for a negative surprise (and adverse market reaction) in today's inflation report.
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