Tuesday's CPI report likely to show inflation continuing to run hot, putting the Fed in tough spot

Tuesday’s report of the consumer price index could set the tone for markets ahead of next week’s Federal Reserve meeting, particularly if it is hotter than expected.

The CPI is expected to have risen 0.4% in August month over month, according to a Dow Jones consensus estimate. On a year-over-year basis, CPI would then be up 5.4%, the same pace it was in July. Excluding food and energy, CPI is expected to rise 0.3% or 4.2% year over year, according to estimates.

The data is set for release Tuesday at 8:30 a.m. ET.

Inflation data has been coming in stronger than expected, raising concerns it may be more persistent than Fed officials believe it to be. The Fed meets next Tuesday and Wednesday and is widely expected to discuss tapering its bond-buying program but not formally announce its plans until later in the year.

But some market pros say another warning about rising inflation could speed the Fed’s timetable even though August’s employment report was weaker than expected. Some market pros pushed back their expectations for a Fed announcement after August jobs gains totaled just 235,000, about 500,000 less than expected.

“If inflation is hot that would imply a little bit faster timeline from the Fed,” BMO U.S. rates strategist Ben Jeffery said. He noted he would expect a higher-than-expected pace to send interest rates higher.

CIBC Private Wealth U.S. chief investment officer David Donabedian said a hotter number could be a worry for stocks and send bond yields higher. Yields move opposite price.

He said the market will be focused closely on what components of the CPI are showing higher inflation rates.

Donabedian added he is watching to see if temporary Covid-related sources of inflation, such as hotels and airfare, began to ease, or if inflation was due to supply shortages. He said it now appears that supply chain issues are more severe than they seemed even just three months ago, and he expects inflation to continue to be an issue.

“Certainly the trend has been for the inflation number to come in above expectations. I think if that happens again, it will feed this narrative that high inflation is going to stick around longer than the Fed had been planning,” he said.

Donabedian said he sees about a 1-4 chance a hot CPI number could prompt the Fed to move sooner to announce the tapering. He said he is watching to see if things that might be more persistent, like rising rents will show up in the number.

“The Fed keeps saying they see inflation as being transitory. Yet the inflation data is getting worse rather than better,” CFRA chief investment strategist Sam Stovall said. “If it’s hotter than expected, I think the stock market’s going to continue to be soft. I think investors are trying to decide whether there’s more to this worry, than not.”

Stocks posted a mild comeback Monday following five days of losses for the Dow Jones Industrial Average partly tied to the inflation concern.

Some Fed officials in recent weeks have said they believe the central bank should start paring back its $120 billion a month bond purchases sooner rather than later. But Fed Chairman Jerome Powell has said he wants to see more strong employment reports before tapering is announced.

Stovall said he does not expect a formal announcement until November. The Fed’s move away from the bond purchase program would be its first major step away from it easy policy and ultimately sets the stage for interest rate hikes.

“If we end up with both headline and core CPI stronger than anticipated, I think certainly statements will be made regarding inflation, while it might not force them to say anything about tapering sooner,” Stovall said.