When will inflation give the Fed breathing room?

Deutsche with the note:

Economic forecasters and inflation traders are widely expecting tomorrow’s CPIrelease to show another 7-plus percent number for year-on-year inflation in January, setting up a new record for the post-Volcker era. Compared to a month ago, expectation for the timing of peak inflation has been pushed further back, as both DB economists and the TIPS market see another likely increase for February. Comparatively speaking, TIPS traders expect inflation to be stickier, with a more substantial increase for next month’s print and 7-plus percent CPI to last throughMarch. Crucially, the next two CPI releases will take place around the March FOMCmeeting, where markets expect the Fed to lift off rates by as much as 50bp.

There is little disagreement that inflation will almost certainly be heading lower toward the latter part of this year. But the February and March CPI prints come at a critical juncture for the Fed, thus raising the stakes for everyone. Signs of the inflation trend reversing by next month would no doubt be a welcoming development and provide the Fed cover for a more flexible approach in policy adjustments. However, if inflation proves to be stickier instead, such as what the TIPS market is suggesting, and if the path of peak inflation keeps getting pushed back, expectations for more aggressive action could build, and the Fed may find it more difficult to communicate restraint despite inflation falling soon after the liftoff.

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