Why today's US inflation report may shock to the downside, in one chart

Of all the major economic data releases out today, none will get as much attention from markets than US consumer price inflation (CPI).

Forget China’s trade data, and the US retail sales report, what markets are most interested in is whether inflationary pressures are building given the implications on the outlook for US interest rates.

Of the 71 economists polled by Thomson Reuters, the median economist forecast is looking for an increase in headline CPI of 0.2% in December, seeing the year-on-year rate decelerate from 2.2% to 2.1%.

However, if the chart below in anything to go by, markets could be in for a big surprise.

Source: RBC Capital Markets

From RBC Capital Markets, it shows the relationship between US producer price inflation (PPI) for finished consumer goods overlaid against headline US CPI.

After receiving Thursday’s US producer price inflation report for December, Tom Porcelli, Chief US Economist at RBC Capital Markets, says the risks to today’s inflation number lie to the downside.

“PPI came in lighter than consensus on both the headline and core and the internals suggest some downside risk to CPI today,” he says.

“Specifically, the finished consumer goods component dropped 0.4% after a massive 1.7% advance last month. We always flag this number
as it has a very good relationship with [monthly movements in] CPI.”

Based on the modelling, Porcelli says it points to a paltry monthly increase of 0.02%, considerably below the 0.2% gain eyed by markets.

While core personal consumption expenditure (PCE) is the preferred inflation measure used by the US Federal Reserve, not headline CPI, given the sensitivity of financial markets to inflation readings, a result that soft, should it be replicated in reality, clearly carries the potential to place downside pressure on both the US dollar and bond yields.

We’ll find out the answer at 12.30am AEDT, or 8.30am EST in New York.

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