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Next Thursday we get the latest inflation data from the US, and overall, it could be bad news for the economy. However, there is so much agreement that inflation is going to be high, and most investors are pricing in a rate hike by the Fed as soon as possible. Therefore, the market doesn’t have much to react to on the upside.

If for some unexpected reason though, inflation were to come in significantly lower, that could shake up the markets. More importantly, there are a couple of components that could have a bigger impact than the headline number that will get the most coverage in the press.

So, let’s break this down to see which parts could potentially move the markets. And why the market might not react much even if inflation comes in higher than expected.

Expectations Vs. reality

The range of expectations for January inflation numbers goes from 7.0% all the way up to 7.9%. But the consensus is at 7.3%, in comparison to 7.0% in December.

Even if it goes up by just one decimal point, that’s still the highest since 1982. A few more decimal points above don’t significantly move the needle in terms of monetary policy. The Fed realistically can hike only so fast.

Furthermore, the Fed cares more about the core inflation rate, but their expectations are worse. January core inflation could accelerate to 5.9% compared to 5.5% prior. That would be nearly triple the Fed’s target. In other words, the expectation is already really high.

Fast Vs. slow

Regulators have stopped talking about inflation being transitory. Nonetheless, if it gets under control, we won’t see that in the comparable numbers first. This is where the “fast”, but less reliable, measures are important.

Before we can anticipate a drop in the inflation trend, monthly CPI changes have to reduce. Given that a year ago was still in the middle of lockdowns, the annual comparison could show increasing inflation even as the monthly inflation drops.

But, if monthly inflation continues to accelerate, that means it hasn’t “peaked” yet. It could mean that inflation will continue moving higher, despite increased interest rates following the start of the Fed’s taper.

Analysts project that slowing down asset purchases wouldn’t have a major impact on inflation. But if CPI continues to accelerate in spite of the Fed moving hawkishly, this could indicate that it will take more action from the Fed to get inflation under control.

What to look out for

Economists expect the headline monthly inflation rate to stay steady at 0.5%, an indication that inflation could be peaking. Lower monthly inflation could be a sign that inflation might be getting under control.

In turn, this would leave the market feeling more dovish, particularly if core inflation slows down significantly. The projection for this is to come in at 0.5% compared to 0.6% in December. A slight reduction in demand following Christmas is normal, as stores get rid of inventory.

But if there is a drop of several decimals, it could open up the potential for the market to push against some of the perceptions of hawkishness from the Fed. And that could support the stock market and weaken the dollar.