Markets Brace For Inflation’s Big Return
In this week’s free YouTube Video, we prep for the July CPI report, which could play a crucial role in shaping market expectations for inflation. Market-based measures, such as inflation swaps, currently project elevated inflation into 2026, with attention focused on whether upcoming data confirms, accelerates, or challenges these trends.
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Terms and Transcripts by ChatGPT
Defined Terms and Jargon
CPI (Consumer Price Index) – A measure of the average change over time in the prices paid by consumers for goods and services.
Core CPI – CPI excluding volatile food and energy prices, often used to identify underlying inflation trends.
Headline CPI – The full CPI measure including all items, such as food and energy.
PPI (Producer Price Index) – Measures average changes in prices received by domestic producers for their output; a leading indicator for consumer inflation.
PCE (Personal Consumption Expenditures) – An alternative inflation measure used by the Federal Reserve, covering consumer spending patterns more broadly.
Inflation Swaps – Financial derivatives that allow investors to trade future inflation expectations, based on the difference between fixed payments and inflation-indexed payments.
CPI Fixing Markets – Markets used to settle CPI-linked contracts, reflecting expectations of inflation rates for specific months.
Swap Curve – A plot showing the relationship between swap rates and different maturities, indicating market expectations for inflation over time.
ISM Prices Paid Index – A component of the Institute for Supply Management survey measuring prices businesses pay for goods and services; a leading indicator of inflation trends.
Regional Fed Surveys – Economic surveys conducted by Federal Reserve regional banks to gauge local business conditions, including inflation pressures.
RNIF (Risk-Neutral Inflation Forward) – A measure derived from market prices that reflects long-term inflation expectations.
Yield Curve – A line that plots interest rates of bonds with equal credit quality but different maturities, used to gauge economic conditions.
Yield Curve Steepening – Occurs when the difference between long-term and short-term interest rates increases, often reflecting expectations for stronger growth or higher inflation.
Fully Edited Transcript
This week brings the release of the July CPI report, a key event given expectations for inflation to tick higher. Market-based indicators and recent survey data from regional Federal Reserve banks and the ISM suggest inflation could rise meaningfully from current levels. While this is not expected to match the extreme rates seen in 2022 or 2023, it could push inflation back into the 3.5% to 4% range. The market reaction will hinge on whether data confirms this upward trend or shows inflation remaining subdued. In this context, “the market” primarily refers to the inflation swaps market, rather than the stock or bond markets.
For August 12, consensus forecasts call for core CPI to increase 0.3% month-over-month (up from 0.2%), and 3.0% year-over-year (from 2.9%). Headline CPI is expected to decelerate to 0.2% monthly (from 0.3%), while rising to 2.8% annually (from 2.7%). The CPI fixing market points to similar figures, with July’s year-over-year number rounding to 2.8%.
In the inflation swaps market, there is a three-month lag in expirations. Current pricing shows inflation peaking at around 3.4% in May 2026, then gradually declining. Over recent months, market expectations have shifted—forecasts for peak inflation have been pushed out in time, with slightly lower peak levels than earlier projected. If CPI comes in hotter than expected, the curve could move higher and peak sooner.
Currently, one-year inflation swaps are near 3.4%, two-year swaps around 3.0%, and five-year swaps near 2.7%. Since April, inflation expectations have generally been rising across maturities. The five-year swap is especially important—if it rises above 2.8%–2.9%, it would indicate markets see longer-term inflation as a persistent problem.
Recent data supports this caution: the ISM Services Prices Paid index hit 69.9 in July, one of the highest readings since early 2023, while ISM Manufacturing Prices Paid also remains elevated. Both tend to lead CPI by about three months. Regional Fed surveys echo this upward trend.
This week also brings the PPI report on August 14, expected to show year-over-year growth of 2.5% (from 2.3%) and core PPI at 2.9% (from 2.6%). Import/export prices and retail sales arrive on August 15, along with the University of Michigan inflation expectations survey, where the five-year expectation remains at a multi-decade high of 3.4%.
Inflation expectations often move in tandem with Treasury yields. The 10-year yield has been consolidating between 4.20% and 4.50%, while the 30-year has held near 4.80%–4.85%. A rise in inflation expectations could push these higher, steepening the yield curve—potentially positive for banks, provided inflation does not erode margins excessively.
Technical signals suggest the 10–2 yield curve could break toward 1%, driven by rising long-term rates and easing short-term rates. This week’s inflation data could be the catalyst that determines whether that move materializes.
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Hi Mike - It sounds like you think CPI is going to come in hot. Is that right?