The market sold off last week in large part due to concerns about the impact of the Omicron variant of COVID. Those fears dissipated this week as it became evident that Omicron was not as severe as believed and that vaccines would still be effective to a great degree.
This shift helped to produce one of the biggest bounces of 2021, but the market is now focused on the next big obstacle, which is inflation concerns and a less dovish Fed. The market reacted negatively to comments by Federal Reserve Chairman Jay Powell about how inflation was no longer "transitory" but was taking hold in many areas of the economy. The market struggled following those comments, with growth stocks taking a particularly hard hit.
Here on Friday morning the market is anxiously awaiting the Consumer Price Index (CPI) report, which will indicate to what degree inflation is hitting the economy. Expectations are that inflation is running at a 6.7% pace, which would be the highest level in nearly 40 years.
President Biden is pushing the narrative that inflation is already slowing, but the decline in energy prices has been minimal and there are few indications that things such as rents or wages are falling at all.
The CPI number is likely to be very strong, but what we need to watch is the market reaction. This news is not going to be a surprise and is already discounted to some extent, but we will need to wait to see how the market reacts.
Unfortunately, this is not an issue that is going to go away quickly or easily. As soon as the CPI data are released this morning the focus will shift to the Federal Reserve, which will issue its interest rate policy on Wednesday. Powell already has set the stage for faster tapering and potential interest rate hikes, but the timing will become more precise in the next few days.
Ironically, as concerns about Omicron have cooled, hopes for economic growth have been boosted, and that causes greater concern about inflation.
While inflation will be the primary headline worry, there continues to be a huge disparity in the market between the performance of a few big-caps and many smaller individual stocks. Inflation hurts growth stocks and small-caps more than other names, and that just makes the situation more difficult for traders trying to navigate the action.
CPI is due out at 8.30 am ET.
