Traders see next U.S. CPI reading close to 7% as volatile markets try to shake off omicron and Federal Reserve’s hawkish pivot

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Financial markets, still on a rollercoaster ride given the unknown impact of the coronavirus o’micron version and the Federal Reserve’s swift turn, could be in for a new surprise when the next US Consumer Price Index report is published on Friday.

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Traders of instruments such as derivatives known as “fixings” are betting that the year-on-year CPI reading for November will rise by 6.9%, the highest inflation level in nearly four decades. This is slightly above the 6.7% average estimate of economists polled by the Wall Street Journal.

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Much is going on to correct the path of short-term inflation. Prolonged high inflation would suggest that the Federal Reserve needs to raise interest rates sooner – and possibly more – than expected, although the passage of rates will also depend on how severely the O’Micron version affects the economy. affects from.

Fixing traders, many of them from hedge funds and investment banks, have proven closer to the mark than economists are on actual CPI readings. They’re putting money on the line, updating forecasts rather than once or twice a month, and relying on in-depth analysis to take into account volatile commodities like airfares and gas, which others usually don’t. do out. In some cases, hedge funds that trade fixing on the UK’s CPI equivalent, known as the retail price index, have priced everything from airfares to three-button polo shirts, according to one fund manager. Teams have been sent to investigate.

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“This year the fixing has been more spot-on than economists have generally expected,” said Omair Sharif, president of Inflation Insights, a Los Angeles-based research firm. “That’s because fixing isn’t just about net expectations for inflation. They also have premiums due to inflation being higher than you expect, and obviously inflation has strengthened.”

“There’s definitely a lot of money riding on this, it sure is people trying to get an edge and figure out what the data is going to look like,” Sharif said via phone. “But having raw data is not enough. You need someone who knows how to turn the raw data into something that matches the way the index works. ,

Headline US inflation readings have now fallen to 5% or more, or more than double the Fed’s 2% target, for six straight months and another higher number will only testify to the Fed’s view that inflation is no longer as transient. can be seen. The jury is still out, however, whether the Omicron version will lead to more lockdowns and an economic slowdown, or will keep supply chains disrupted and fan further price hikes.

While traders and economists have both underestimated the strength of price pressures this year, the fixings, which relate to the nearly $1.6 trillion market for Treasury inflation-protected securities, are more on point.

Earlier this year, for example, for April, May and June, fixing traded at levels that would drop the headline annual CPI rate to 3.7%, 4.9% and 5.1%, respectively. Actual readings came out to be 4.2%, 5% and 5.4% – placing the fixings closer to economists’ average estimates of 3.6%, 4.7% and 5%.

10 release of previous CPI readings, economists had moved in line with traders — with an average forecast for a headline annual rate of 5.9% in October. The actual reading was 6.2%, highest in almost 31 years,

A difference of 30 basis points or more for April, June and October is still “a huge lapse” in the fixing market, says Gang Hu, where most money is made within 10 basis points of the actual reading. , an inflation trader with New York hedge fund Winshore Capital Partners.

As of Friday, Hu says, were trading at fixing levels, meaning the annual headline CPI rate would be 7% or higher from December to February, even though the US produced its smallest job gains of the year.

“If anything, the fixing has really reduced the actual print throughout the year,” said Chris McReynolds, head of US inflation trading for Barclays plc BARC.
-0.31%
in New York. While some may be “shocked” to see the next CPI print, “I believe most people in the finance world have opened their eyes to the risks of inflation and are familiar with the risks above.”

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Fixing has demonstrated its most enduring predictive power in the UK, where traders have been “exact or very close” for the past 12 months, said Adam Skerry, London-based rates and inflation fund manager at ABDN,
+1.70%,
Formerly known as Aberdeen Standard Investments. Skerry says he relies on Fixing to measure the short-term “direction of travel” in inflation and help him trade everything from 5-year inflation swaps to short-dated TIPS.

“The fixing market was never very focused because it was based on month-to-month readings that were very volatile,” Skerry said via phone. “But now that we are getting out of the inflation range, there is a lot of emphasis on it. Short-dated fixings have become more liquid and can be traded more accurately, allowing some investors to make money out of it. Huh.”

Back in the US, markets have become volatile at a time when the Era of Great Moderation – characterized by low inflation, reduced volatility, and a central bank that does not need to drive policy rates to extreme levels – ends after three years. appears to be. Decades according to Skerry.

Last week’s market action offers a glimpse of the volatility that may still be in store. Major stock indexes and longer-term Treasury yields fell on Tuesday after Fed Chairman Jerome Powell dropped the word “transient” from the central bank’s inflation statement and suggested a faster-than-expected timeline is needed to ease bond purchases. Might be possible.

The market attempted to recover over the next three days, with Dow industrialists taking a wild, nearly 1,000-point swing on Wednesday, before generating their best percentage gain since early March the next day. But as of Friday, all three major stock indexes were posting losses weekly, while 10- and 30-year yields fell to their lowest levels since September and January, respectively.

For markets, perhaps more important than the headline CPI rate on Friday are data underlying details, such as whether there are signs of a broader continuation of price pressures, analysts say.

The next CPI figure “doesn’t need to come in big,” said Gregory Faranello, head of US rates at Amerivate Securities in New York. “This could be overkill to keep the Fed on course for a sharp taper and upset investors. There are no indications that the numbers are going to be meaningfully lower in the short term. We’re seeing this in volatility right now.” are, and we expect more to come.”

What’s on the American Economic Calendar?

Monday

no schedule

Tuesday

Wednesday

Thursday

Friday

fed speaker

Fed officials enter a blackout period ahead of their December 14-15 meeting in Washington.

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