US Inflation Expectations Grind Lower

Contrary to the positive surprise provided by the last week’s US NFP and jobs data, the US inflation profile expectations depict a downbeat scenario ahead of the key US Consumer Price Index data for January.

The US inflation gauge, as measured by the 10-year breakeven inflation rate per the St. Louis Federal Reserve data, fades the gradual recovery from September lows tested on January 20, according to the FRED website.

Recently, the inflation expectations ease to 2.4% by the end of Monday’s North American session, extending the pullback from the highest level in a fortnight tested by the end of January.

Inflationary pressures in the US continued to heat up at the start of the year, data are expected to show, likely putting a Federal Reserve interest-rate increase next month on autopilot. The consumer price index probably jumped 7.3% in January from a year ago, the largest annual advance since early 1982, according to the median projection in a Bloomberg survey of economists. Excluding volatile energy and food categories, the CPI is projected to have risen 5.9%.

The inflation data follow the government’s latest employment report, which showed newfound momentum in the labor market and faster wage growth that spurred bets that the Fed will be more aggressive in raising rates.

It is a light week for Fed-speak, with only the Cleveland Fed’s Loretta Mester and Governor Michelle Bowman scheduled, both on Wednesday. Mester’s a FOMC voter this year and Bowman will be the first governor to make public remarks since Chair Jerome Powell’s press conference on 26 January.

The relative silence from Washington probably reflects the fact that both Powell and Governor Lael Brainard await Senate confirmation — Powell for another four years at the helm, and Brainard to become vice chair.

The Senate Banking Committee expects to vote on them Feb. 15, together with President Joe Biden’s three nominees to join the Fed’s Board of Governors: Lisa Cook, Sarah Bloom Raskin and Philip Jefferson. All five will then require confirmation by the full Senate.

The mixed signals sent by the inflation expectations seem to have been well-received by the US Treasury yields on Monday as the bond coupons pared Friday’s heavy gains around the two-year high, recently near 1.91%.

Given the mixed signals concerning the US CPI, which in turn will help direct the Fed’s next move in March, markets can remain sluggish heading into the key US inflation data.

US inflation data next Thursday may be key to whether the bond rout that has sent Treasury yields to two-year highs is likely to continue, with investors likely to price for more aggressive rate hikes if the number comes in stronger than expected, according to Morgan Stanley.

The Federal Reserve said last month that it is likely to hike interest rates in March as it tackles persistent inflation, though fed funds futures traders are pricing in only a 37% chance of a 50 basis point increase that month. Five increases of 25 basis points are priced in by December.

Consumer Price Index data on Thursday is expected to show that prices rose 0.5% in January, and are up 7.3% on the year, according to the median estimate of economists polled by Reuters. However, an upside surprise next Thursday would mean further talk of the Fed raising rates 50bp in March. At a minimum, calls for the Fed to hike at every meeting this year will look much less off-base.

An upside surprise on January US CPI next week followed by further strength in nonfarm payrolls and even more inflation in February could get expectations of a 50bp hike in March to solidify. That outcome would certainly jolt expectations for Fed policy this year.