Market Extra: Why March’s CPI report could upset the stock market, seal the deal on the next rate hike 

Investors in the U.S. stock market will be closely watching Wednesday’s inflation report as it would be one of the last key data points before the Federal Reserve’s next interest-rate move.

Employment data for March, released on Friday, indicated a resilient labor market, and was viewed as boosting the chances of another 25-basis-point rate hike next month. 

The March CPI reading from the Bureau of Labor Statistics, which tracks changes in the prices paid by consumers for goods and services, is expected to show a 5.2% rise from a year earlier, slowing from a 6% year-over-year rise in the previous month, according to a survey of economists by Dow Jones.

“If the headline CPI meets expectations or misses some, it isn’t going to matter,” said Michael Kramer, founder of Mott Capital Management, adding that the Fed likely will raise rates by about 25 basis points in May.

“The odds of a Fed rate hike have increased to 70% from around 50% before [Friday’s] jobs report,” he said, adding that unless there is a significant miss on the CPI, the Fed will boost its policy rate above 5% “because inflation remains too high.”

Core CPI, which strips out volatile food and fuel costs, is expected to rise 0.4% from a month ago, or 5.6% year over year. The increase in the core rate over the 12-month period dipped to 5.5% in February.

If core CPI meets expectation, it will be the first time since September that it increases at a faster pace than the previous month, and the first time since the beginning of 2021 that the core rate is rising faster than headline CPI.

See: What’s next for the stock market after jobs report lands on Good Friday holiday

Friday’s solid employment report for March, which shows a historically low U.S. unemployment rate and rising wages, firmed up expectations that the Federal Open Market Committee will raise interest rates one more time in its tightening cycle. A day before the release of jobs data, traders in the fed-funds-futures market saw roughly a coin flip’s chance that the Fed would make no move on rates as growing recession fears took center stage, according to CME FedWatch tool. 

“This development may upset the equity market, as it has already priced in a Fed pause and rate cuts, given the recent rally since mid-March and the strong performance in the technology-heavy and interest rate-sensitive Nasdaq,” Kramer said in a Sunday note. 

The recent rally in megacap and growth stocks may be “overdown and must be corrected” if the economic data continue to support another rate hike in May and no rate cuts by the end of 2023, said Kramer. 

See: Why a closer look at stock-market performance reveals a ‘very muddled picture’

However, a dizzying rally in growth stocks started to fade last week with the Nasdaq Composite

booking its first losing week in four amid recession concerns. The index fell less than 0.1% on Monday, while the S&P 500

advanced 0.1% and the Dow Jones Industrial Average

gained 0.3%. 

However, as CPI report is expected to give further confirmation that inflation isn’t yet sustainably slowing down and may keep the Fed raising rates again, market participants may take longer to price out substantial rate cuts in the second half of 2023, said economists at Citi.

“Markets are likely to continue pricing a high probability of rate cuts from the Fed later this year even with a strong CPI print, with cuts priced out only after a number of weeks of consistently solid activity and strong inflation data,” wrote Citi economists Veronica Clark and Andrew Hollenhorst, in a Monday note. 

Bond market is also likely to be more sensitive to a downside surprise in CPI after a week of U.S. Treasury yields moving lower on softer economic data. “Still, an increase in core CPI should still elicit a significant move higher in yields, especially following a still-solid March employment report,” Clark and Hollenhorst said. 

Treasury yields advanced on Monday with the yield on the policy-sensitive 2-year Treasury note

rising to 4.003%. 

In the foreign exchange market, the fact that core inflation isn’t receding as fast as markets have hoped could offer the U.S. dollar “just a brief respite,” if markets further trim rate cut expectations for the Fed, said Roberto Mialich, FX strategist at UniCredit. 

“Yet, this cannot be enough to challenge the prospect of a lower U.S. dollar in the future, as interest-rate differentials between the U.S. and the rest of the world are expected to tighten further,” Mialich said in a Thursday note. 

The ICE U.S. Dollar Index
which measures the greenback’s strength against a basket of six other currencies, jumped 0.5% to 102.57 on Monday. 


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