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Before The Bell: Inflation and Interest Rates Become Market Focus

Bonds and stocks finished with small gains Tuesday. The run-up in rates since the start of the new year has finally stalled. Strong demand for the 10-year auction was the catalyst. Also buyers stepped in after the long bond tested 1.92% and the 10-year climbed to 1.19%, the highest levels since mid-February on the bond and mid-March on the 10-year. Wall Street also pared early losses and finished with small gains as yields fell. The Dow managed to close just over the 31,000 mark, with the S&P 500 at 3803, while the NASDAQ was just above the 13,000 level, all just shy of record highs. The markets seem to be stabilizing and consolidating for now after a crazy first week of 2021 trading, pricing in virus, vaccines, lockdowns, stimulus, and possible Fed tapering.

  • U.S. data calendar has Dec CPI, MBA mortgage and oil inventory figures
  • Canada calendar thin for the rest of the week
  • Dollar lifted out of lows; EUR-USD down after Villeroy warned about rising euro
  • EGBs have moved higher with Treasuries, stock markets little changed
  • ECB’s Villeroy: policymakers are watching impact of exchange rate moves carefully
  • ECB’s Lagarde: lockdown extensions beyond March would be very worrying
  • Eurozone November production stronger than expected at 2.5% m/m

A lot of focus will be on CPI today as inflation has become a factor boosting Treasury yields this year. The headline rate is expected to rise 0.4% overall after November’s 0.2% increase, while on an ex-food and energy basis, prices are seen edging up 0.2%, as it did in December. Weekly MBA mortgage and oil inventory figures are due as well. The December Treasury budget is due late in the session, along with the Beige Book for the January 26-27 FOMC. The Treasury auctions $24 bln of reopened 30-year bonds. after a strong 10-year sale yesterday. For Fedspeak, VC Clarida, Brainard, and Harker are on deck. The House is expected to vote on impeaching President Trump for a second time.

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CPI/Core: 0.4%/0.2%

We expect November gains of 0.4% for the CPI headline and 0.2% for the core, following 0.2% gains for both in November. CPI gasoline prices look poised to bounce 8.2% in December, leaving a tailwind for the headline. As-expected November figures would result in a 1.3% headline y/y increase, following a 1.2% pace in November and October. Core prices should show a 1.7% y/y rise, up from 1.6% in November. As with PPI, the headline inflation figures were lifted by oil prices over the summer, and now later into December, while the core figures face divergent pressures from diminished demand but growing supply bottlenecks that remain problematic into Q1. We expect headline y/y gains for all the inflation gauges to climb sharply into Q2 of 2021 due to hard comparisons, leaving a peak headline CPI y/y gain in the 3.4% area in May, alongside a 2.7% y/y core price rise, with respective PCE y/y chain price gains of 2.5% and 2.0%. The Fed will face no pressure to withdraw accommodation any time soon despite the expected temporary Q2 inflation spike.

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