According to market commentators, the stock market’s early-year gain is doomed if a highly anticipated U.S.

CPI report on Tuesday kills hopes for a faster decline in the cost of living in America.

According to a Dow Jones survey of experts, the January CPI data from the Bureau of Labor Statistics, which analyzes changes in the prices paid by consumers for goods and services, is projected to show a 6.2% year-over-year gain, dropping from a 6.5% year-over-year rise reported in the previous month.

The core price index, which excludes volatile food and energy expenses, is forecast to grow 0.4% from December, or 5.5% year on year.

“Any core result below 5.5% is likely to be a short-term positive catalyst for stocks, and any reading above 5.5% is likely to be seen unfavorably by the markets in the very short term,” said George Ball, chairman of Sanders Morris Harris.

Investors are Getting Too Optimistic

On Monday, U.S. stocks finished substantially higher as investors weighed different signs for what the publication of consumer price data would reveal.

The Dow Jones Industrial Average finished 377 points, or 1.1%, higher at 34,246.

The S&P 500 rose 1.1%, while the Nasdaq Composite rose 1.5%, after stocks suffered their worst weekly losses in over two months.

The Inflation Nowcast from the Federal Reserve Bank of Cleveland predicts a higher-than-expected CPI figure.

As of Monday, the Cleveland Fed’s model predicts that headline CPI would grow 0.65% month over month or 6.5% year on year.

The tracker forecasts a 0.46% monthly increase and a 5.6% year-on-year increase in core CPI.

“This model has had a mixed track record recently, but it is generally good at predicting inflation patterns,” said Nicholas Colas, co-founder of DataTrek Research.

That implies that if these forecasts hold, the stock market’s anticipation that inflation will fall back to the Fed’s 2% objective anytime soon may be dashed.

Meanwhile, a New York Federal Reserve consumer poll found that inflation forecasts for 2023 were constant from 5% in December.

According to the New York Fed, three years from now, inflation is forecast to be 2.7%, while five years from now, inflation is expected to be 2.5%.

Market is Wishing for a Slower Pace

Stock market investors betting on a slower pace of rate hikes and a terminal rate near 5%, have celebrated in the past two weeks after Fed Chair Jerome Powell stated in his post-FOMC news conference that “the disinflationary process” is underway.

According to the CME’s FedWatch tool, Fed funds futures traders are pricing in a 76% chance that the fed-funds rate would hit 5-5.25% by May.

A higher-than-expected inflation estimate on Tuesday may signal a shift in the equities market’s expectations for inflation and interest rates, with “far-reaching repercussions,” according to Michael J. Kramer, Founder of Mott Capital Management.

Despite warnings from many sectors of the markets, Kramer believes the equities market has been in “fantasy land” and that investors do not appear to be “greatly concerned” about the upcoming CPI report.

“It appears that the equity market is still naive to the predicted increase in inflation from analysts and the warnings from the inflation swaps, options, and bond market about a likely trend of higher-than-previously-expected inflation in the future,” Kramer wrote in a Sunday note.

“If CPI comes in hotter than predicted, the equity market may once again find itself on the wrong side of the trend, as it has multiple times in the last year.“

New CPI Parameters

The revised weightings for the CPI calculation issued by the Bureau of Labor Statistics (BLS) on Friday added to the potential volatility.

To weigh the CPI components, the bureau revised its approach from using consumption data over a two-year period to simply one year.

The BLS also revised the spending weights used to calculate the CPI, which will take effect with the January CPI report and affect the amount of influence the individual components have on readings.

For example, the value for shelter will increase dramatically to 34.4% from 32.9%, while the proportion for food will decrease to 13.5% from 13.9%.

According to Kramer, used automobile and truck prices have dropped to 2.66% from 3.62%.

“These adjustments in weighting could result in the CPI running hotter to start the year. For example, the inflationary impulse from the owner’s equivalent rent is likely to persist for some time, whereas the impact of dropping used car prices will be less evident,” Kramer remarked.

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