Investors are underestimating inflation again

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Investors are holding their breath in anticipation of Thursday morning’s Consumer Price Index inflation report — arguably the most important piece of economic data so far this year.

There’s a lot riding on the outcome — if inflation keeps falling, that could support a market rally, while higher-than-expected inflation could send stocks sinking.

What’s happening: After a stormy 2022, the Federal Reserve’s battle against inflation has become the chief preoccupation on Wall Street — with investors ascribing significant meaning to any economic data that could indicate what the Fed does next.

But recent data has been muddy. December’s hotly anticipated jobs report had something for everyone — easing wage growth and easing unemployment. Fed meeting minutes, released last week, also didn’t offer much in the way of conclusive answers.

That’s why this CPI report will command attention and go a long way toward shaping market expectations for the first Federal Reserve policy meeting of the year.

The Fed Funds Futures market still sees a high probability of a quarter percentage point rate hike on February 1, but the results of the CPI report could change that.

What Wall Street expects: Inflation cooled more than expected in October and November, leaving investors optimistic that the downward trend will continue into December and beyond. But a key reading of trading data tied to inflation suggests they expect inflation to fall faster than economists and Fed officials do.

December’s consumer prices are estimated to have increased 6.5% on an annual basis, down from 7.1% in November, according to economists surveyed Refinitiv. On a monthly basis, CPI is expected to show no change versus November.

Yet inflation swaps, transactions in which one investor agrees to swap fixed payments for floating payments tied to the inflation rate, are indicating that investors believe inflation will come down to 2.5% in the next seven months, even as the Fed’s own projections say inflation will remain well above 3% until 2024.

The inflation swaps market is considered one of the easiest ways to gauge how the market thinks inflation will change over the next 12 months. Current expectations for a sharp fall in CPI indicates that investors think the Fed will likely cut rates this year in response to falling inflation levels.

The takeaway: Investors seem to keep forgetting a cardinal market rule: Don’t fight the Fed.

​​”The expectation with this week’s Consumer Price Index is for further easing of inflation pressures. Anything less than broad-based improvement will rattle investors’ nerves and keep the Fed active,” said Greg McBride, chief financial analyst at Bankrate.

Bets that the Fed will soon pivot away from elevated interest rates, even as officials say that they won’t, could mean more market volatility lies ahead.

Asian stocks enter bull market as investors bet on China

US stocks may be volatile, but in Asia markets are soaring.

Investors, buoyed by China’s pivot away from its economically painful zero-Covid policy and an easing of regulations on tech companies, are piling cash into the world’s second biggest economy.

The MSCI Asia Pacific index, which excludes Japanese companies, jumped 2.5% during Tuesday trading to close the day at 535.69 points. That’s up 24.6% since its most recent low on October 24, reports my colleague Anna Cooban.

A rebound in investor sentiment toward Chinese stocks has driven the rally. The MSCI China index rose 2.4% on Tuesday to stand 50% above its low on October 31. Hong Kong’s Hang Seng index has jumped 38% over the same period.

Nasdaq’s Golden Dragon China index — which tracks Chinese companies listed in the United States — rose 0.72% on Monday, putting it 71.3% above where it was trading in late October.

Analysts at Morgan Stanley said in a Tuesday note that the bank had raised its share price targets for Chinese companies and “expect[s] China to top global equity market performance in 2023.”

Wells Fargo steps away from mortgages

Wells Fargo was once the number one player in the multi-trillion dollar US mortgage market. Now, the scandal-ridden bank is taking a step back as it grapples with the impact of higher interest rates and regulatory trouble.

The company announced on Tuesday that it would refocus its mortgage business on serving bank customers and minority homebuyers instead of acquiring new customers, reports my colleague Matt Egan.

The retreat will likely cause Wells Fargo to lay off at least some employees, though the bank did not announce any specifics. A spokesperson declined to comment on potential layoffs.

“Mortgage is an important relationship product, and our goal is to continue to be the primary lender to Wells Fargo bank customers as well as minority homebuyers,” Kleber Santos, Wells Fargo’s head of consumer lending, said in a statement.

The move comes as Wells Fargo continues to be in trouble with regulators. Last month, the Consumer Financial Protection Bureau ordered Wells Fargo to pay a record fine of $1.7 billion for “widespread mismanagement” over multiple years that harmed 16 million customer accounts.

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