The February CPI Report May Deliver A Big Shock To Markets

Due to be released on the morning of March 12, this February CPI report is expected to be another hot inflation reading, hotter than the one in January. This could be an essential reading because, as it stands, that would be two months of inflation readings hotter than what was seen at the end of 2023.

The problem is that while economists are looking for a hot number, inflation swaps are pricing in something even hotter, which is the real risk for this week’s CPI report.

Swaps Predicting A Hot Number

Currently, forecasts call for headline CPI to rise by 0.4% m/m, up from 0.3% in January, while rising by 3.1% y/y, in line with last month. Core CPI is expected to rise by 0.3%, down from 0.4% last month, and fall to 3.7% y/y, down from 3.9%.

Inflation swaps see things a bit hotter and are currently at 0.46%, which would round up to a gain of 0.5% m/m. Swaps are also pricing in a gain of 3.18% y/y, which would round up to 3.2%. So, at least currently, the swaps market is expecting a headline CPI number to come in 0.1% hotter on both m/m and y/y, and have been steadily trending higher over the past month.

Other models are also pricing in slightly higher readings for the February CPI report. Kalshi, an online website that collects user data, predicts CPI will rise by 3.23% in February. The Cleveland Fed is currently pricing an increase of 3.12%, while Bloomberg Economics sees inflation at 3.07% in February.

Swaps Predict Higher Inflation

One reason for this expectation surge has been the move higher in gasoline prices in February, surging by 4.6%. The outlook thus far in March shows that gasoline is up an additional 4.25%. Indeed, rising gasoline prices are one reason inflation is expected to be hot.

But more importantly, swaps don’t see the February inflation print as a one-off. Inflation swaps are pricing in headline CPI rising to almost 3.4% in March and then slowly coming back down to 3.1% by June. Remember, it was June 2023 that saw headline CPI print at 3%, which seems to suggest that the progress in headline CPI has stalled over the past year.

The estimates for June have generally been rising as well. In July 2023, CPI swaps for June 2024 were pricing a year-over-year headline rate of 2%. Clearly, that outlook has changed, and based on the data at the moment, we have come full circle.

Fed Not Likely To Feel Comfortable

If inflation swaps turn out to be correct, it may take somewhat longer for the Fed to feel comfortable with cutting rates, and it could delay the process from starting until July or September if the Fed is trying to see continued good reports. Because the data in January, combined with the expected data in February, would go against the data seen at the end of 2023, which saw m/m headline inflation steadily trending lower. February data would make for two months in a row above 0.2%, and right now, CPI swaps see inflation rising by 0.3% m/m in March.

A hot February report would put into question when the Fed starts cutting rates. The later the Fed starts cutting, the more likely it becomes that the number of rate cuts coming in 2024 will go from 3 to 2 or possibly 1. More importantly, a hot CPI report could be reflected in the dot plot that the Fed will produce at its March meeting.

The swaps market is telling us not to take our eyes off inflation.