US January CPI: What it Means for the Dow Jones

Another decades-high inflation print is forecast for January, which after a surprisingly good NFP, could make a 50 basis point hike by the Fed a done deal. What does it mean for the Dow Jones?

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Expectations

The recent turbulence in the stock market finds its roots at the expectation for tighter monetary policy in the coming months. Pulses are racing ahead of Thursday's US CPI numbers since it is inflation that is behind Fed hawkishness.

The consensus is that the US January CPI will accelerate to 7.3% annualized, up from 7.0% annualized in December, which was the highest rate of consumer price inflation since 1982. For a point of reference, ‘Come On Eileen’ topped the charts that year!

Economic data that suggests relatively higher interest rates in the US than elsewhere naturally supports the dollar and could be problematic for risky assets. However, the market is already expecting a strong response from the Fed over the coming months so the bar for exceeding those expectations is higher.

Inflation, Fed, and indices

The increased probability of tighter policy would affect all three major US indices, but arguably the Dow could be affected the least. That’s because it is composed of blue chip stocks, mainly in the industrial sector that are not as heavily impacted by higher interest rates. This is evident from the year-to-date performance whereby the Dow is lower by 2.4%, while the Nasdaq is down 9.27%.

An upside surprise might increase calls for the Fed to hike half a point. The markets currently prices in only a 25% probability of a 50 basis points raise. Before last week's upbeat NFP, the exact expectations were minuscule at 6.6%. Were these odds to increase to over 50%, indices could start feeling the heat.

Alternatively, inflation missing expectations would be the biggest "surprise." In particular, participants should be interested in faster measures such as monthly comparisons. Even if year-over-year inflation rises, month-over-month inflation could reduce, which might signify that we are at or past the peak of inflation. Core monthly CPI change is expected at 0.5% compared to 0.6%.

DJIA Prepares for Breakout

Current price action shows the 50-day MA resists bulls, and the 200-DMA keeps bears at bay. The tight consolidation between 35550 and 35090 signals a soon-to-come breakout.

A break above the 50-day average will bring the 36580 high into play. Above that, an all-time high is within reach. Below the support lies the 34850 low, followed by an inside bar rejection above the 200-day average. If support gives way, the index could decline to 33,150.

Source: Spreadex Trading Platform

Key Takeaways

Higher inflation implies higher interest rates, and possibly a bigger 50 bp hike in March from the Fed. The uncertainty this would generate could be an issue for all risky assets like stocks but money managers that need to be fully invested might move from high valuation stocks into industrial "value" stocks in the DJIA, limiting the damage.

If month-on-month figures decelerate significantly, it could signify that inflation is ready to move lower. And that would support the notion that the market has gotten ahead of itself in forecasting too strong a hiking cycle, offering a chance for dip-buyers.