The majority of investors cite the surprising increase in average hourly earnings as the tipping point in their concern about higher inflation with the resulting higher long-term interest rates. This reaction likely influenced the sharp decline in equity markets. As a result, moribund equity volatility responded with a vengeance creating a market reaction that belied underlying strength of economic fundamentals.
This Wednesday morning at 8:30AM EST the January consumer price index (CPI) will be released. It will be the first measure of inflation since the issuance of the average hourly earnings numbers.
According to a Goldman Sachs report, the consensus January YoY CPI forecast is 1.9% compared to the prior month of 2.1%. On the same basis, the core CPI forecast is 1.7% compared to 1.8% for the prior month. If the consensus proves close to the mark, these results should tone down investors’ inflation concerns. Of course, if the report turns out to be substantially higher than expectations, then investors will likely show further concerns.
In our view, the underlying economic fundamentals remain strong as the domestic economy moves through its maturing cycle. The global economy shows growing strength. Despite the equity market gyrations, we expect the Fed to increase the Fed funds rate in March. Not to do so would send a bad signal to both investors and business leaders.
With this as background, we continue to expect a steepening in the yield curve and therefore investors should pull back from longer-term notes and bonds. On the equity side, a steepening yield curve would make financials more attractive. With the maturing of our economy, industrials normally benefit. The maturing economy, global growth, and a weak dollar, will strengthen commodities.
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