Stocks Before the Market: Investors Underestimate Inflation…Again

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New York

Investors are holding their breath as they await Thursday morning’s Consumer Price Index inflation report — arguably the most important economic data of the year.

Much depends on the outcome — if inflation continues to fall, that could support a market rally, while higher-than-expected inflation could send stocks down.

What is happening: After a tumultuous 2022, the Federal Reserve’s battle against inflation has become a major preoccupation on Wall Street — with investors attaching significant importance to any economic data that could indicate what the Fed will do next.

But recent data is murky. The hotly anticipated jobs report for December had something for everyone — a slowdown in wage growth and a drop in unemployment. The minutes of the Fed meeting, released last week, also did not offer many definitive answers.

That’s why this CPI report will garner attention and go a long way in shaping market expectations for the Federal Reserve’s first policy meeting of the year.

The Fed Funds Futures market still sees a high probability of a quarter percentage point rate hike on February 1, but the results of the CPI report could change that.

What Wall Street Expects: Inflation cooled more than expected in October and November, leaving investors optimistic that the downward trend will continue in December and beyond. But a key reading of inflation-linked trading data suggests they expect inflation to fall faster than economists and Fed officials does.

Consumer prices are estimated to have risen 6.5% year-on-year in December, down from 7.1% in November, according to economists polled by Refinitiv. On a monthly basis, the CPI is expected to be unchanged from November.

Still, inflation swaps, transactions in which an investor agrees to exchange fixed payments for variable payments tied to the rate of inflation, show investors believe inflation will ease to 2.5% over the next seven months, even though the Fed’s own projections say inflation will remain well above 3% by 2024.

The inflation swap market is considered one of the easiest ways to gauge how the market thinks inflation will change over the next 12 months. Current expectations for a sharp decline in CPI indicate that investors think the Fed is likely to cut rates this year in response to falling inflation levels.

To take away: Investors seem to keep forgetting a fundamental market rule: Don’t fight the Fed.

“With this week’s consumer price index, inflationary pressures are expected to ease further. Anything less than a general improvement will rattle investors’ nerves and keep the Fed active,” said Greg McBride, chief financial analyst at Bankrate.

Bets that the Fed will soon turn away from raising interest rates, even though officials say they won’t, could mean more market volatility is ahead.

US stocks may be volatile, but in Asia markets are rising.

Investors, spurred by China’s move away from its economically painful zero-covid policy and easing regulations on tech companies, are pouring money into the world’s second-largest economy.

The MSCI Asia-Pacific index, which excludes Japanese companies, jumped 2.5% in trading on Tuesday to close the day at 535.69 points. That’s up 24.6% from the most recent low on October 24, my colleague Anna Cooban reports.

A recovery in investor sentiment towards Chinese stocks fueled growth. The MSCI China index rose 2.4% on Tuesday and remained 50% above its lowest level since Oct. 31. Hong Kong’s Hang Seng index jumped 38% over the same period.

Nasdaq’s Golden Dragon China index — which tracks Chinese companies listed in the United States — rose 0.72% on Monday, putting it 71.3% above where it traded in late October.

Morgan Stanley analysts said in a note on Tuesday that the bank raised its stock price targets for Chinese companies and “expect[s] China will be the best in the global stock market in 2023.”

Wells Fargo was once the number one player in the multi-trillion dollar US mortgage market. Now, the scandal-plagued bank is taking a step back as it grapples with the impact of higher interest rates and regulatory issues.

The company announced Tuesday that it will refocus its mortgage business on serving bank clients and minority homebuyers instead of acquiring new clients, my colleague Matt Egan reports.

The withdrawal is likely to cause Wells Fargo to lay off at least some employees, though the bank has not released any details. A spokesman declined to comment on potential layoffs.

“Mortgage is an important relationship product, and our goal is to continue to be the primary lender to Wells Fargo’s customers as well as minority homebuyers,” Kleber Santos, Wells Fargo’s head of consumer lending, said in a statement.

The move comes as Wells Fargo continues to struggle with regulators. Last month, the Consumer Financial Protection Bureau ordered Wells Fargo to pay a record $1.7 billion fine for “pervasive mismanagement” over several years that damaged 16 million customer accounts.

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