Inflation Revival Persists as Market Risk Despite CPI-Fueled Rally

The recent consumer price index (CPI) data for December has sparked a relief rally in stocks and bonds, with the benchmark S&P 500 jumping 1.8% and the 10-year Treasury yield falling back to 4.66%. However, market participants remain anxious about the pace of inflation and the uncertainty surrounding the outlook for further Federal Reserve interest rate cuts and incoming President Donald Trump's policies. Despite the CPI-fueled rally, persistent inflation concerns linger, driven by several key factors.



Firstly, uncertainty about the Fed's rate cut outlook persists. Even though the CPI report showed a modest increase in core inflation, markets are still uncertain about the Fed's plans for further interest rate cuts. The Fed has been tempering its outlook for rate cuts, and investors are waiting for more clarity on this front. Secondly, there are concerns about the potential impact of President Trump's policies on inflation. His actions on issues like taxes and tariffs could feed into inflation or growth, adding to market anxiety. Additionally, fiscal policy changes coming over the next year are another factor contributing to persistent inflation concerns. These changes could have significant implications for the economy and inflation.

Moreover, changes to tariffs and the trade regime could potentially increase core goods inflation for a time, adding to inflation risks. Market volatility is also a concern, with investors expecting daily moves of 10 to 15 basis points for the 10-year Treasury to become the new norm. Lastly, investors are still concerned about the potential for higher inflation and the uncertainty surrounding the economic outlook. This is reflected in the pricing of inflation options, which show that investors assign roughly similar odds to inflation returning to the ECB's 2 percent target and inflation remaining around 4 percent in Europe. In the United States, investors appear to put high odds on inflation being above target at around 3 percent.



In conclusion, while the recent CPI data has sparked a relief rally in stocks and bonds, persistent inflation concerns remain a significant risk for the market. The uncertainty surrounding the Fed's rate cut outlook, President Trump's policies, fiscal policy changes, tariffs and trade regime changes, market volatility, and inflation risks continue to weigh on investors' minds. As the market remains data-dependent, investors will continue to monitor these factors closely and adjust their expectations accordingly. Despite the CPI-fueled rally, investors should remain vigilant and prepared for potential headwinds in the coming months.