As has been the case for many months now, the market will be paying close attention to the Consumer Price Index (CPI) when the U.S. Bureau of Labor Statistics (BLS) releases December data Thursday morning.
The CPI tracks the price changes on a market basket of consumer goods and services. It's a key way investors gauge inflation, which is a key determinant of what will happen to the economy and the market this year.
The Federal Reserve is still looking for more proof that inflation has peaked and will start to slow as the year progresses. Will the CPI continue to head in the right direction tomorrow? Let's take a look.
Inflation seems to be cooling
After more than a decade of low inflation and low interest rates, inflation came on strong in late 2021 and accelerated into 2022. The Fed would eventually realize that inflation was not "transitory" as it had once assumed and that it was behind the curve.
The CPI zoomed higher in early 2022. By the middle of the year, it had jumped more than 9% year over year, as pent-up demand and excess savings from the pandemic led to price hikes across the board. At that point, the Fed began to raise its benchmark lending rate, the federal funds rate, aggressively to try to get inflation under control.
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But with the bulk of the Fed's rate hikes coming in the back half of last year, it's still unclear whether or not the Fed has won its war with inflation. The labor market is still by and large strong, and the CPI bobbed up and down for most of 2022.
Over the last two months, there has been some progress. In October, the CPI rose by 0.4% from September, which is the same amount of growth seen in September on a month-over-month basis.
In October, the CPI rose 7.7% year over year. In November, the CPI only rose 0.1% from October and was up 7.1% year over year, showing even more proof that inflation was cooling.
While this looks like the beginning of a trend, investors will be looking for further signs of cooling inflation tomorrow, because there were months in 2022 when it looked like inflation was cooling only to bounce back up.
The Fed has been saying that it still has more work to do in its war with inflation, particularly when you look at how strong the labor market is, which is driving consumer spending.
How will the market react tomorrow?
It's always tough to know how the market will react to certain data, which is why I would never recommend buying and selling stocks around an event like this. But ideally, investors should react positively if inflation shows further signs of cooling.
The Federal Reserve Bank of Cleveland's Nowcasting model expects the December CPI to have risen about 0.1% from November and come in at 6.6% year over year. If the numbers come in below these estimates, I'd expect the market to react favorably unless prices drop too severely, in which case the market may get concerned about a severe recession. If the numbers are decently above the forecast, then investors may get worried about persistent inflation.
I'm also specifically focusing on the prices related to shelter and rent, which have not declined in nearly the same capacity as other prices and can be a big source of inflation, given how costly these expenses are.
The CPI report tomorrow is likely to play a big role in determining how large the Fed's next rate hike will be, and also potentially in when the Fed will end its rate-hiking campaign, so investors should definitely tune in.
