Financial Tips

Are Traders Truly Fearful of Inflation?

Inflation: This week, investors received surprising inflation-data. The surprise wasn’t that inflation is here…rather, how much of it is here.

Of course, members of the Fed have told us that inflation-spikes will only be temporary – we shouldn’t fear. But that didn’t stop the market from rolling over last week based on inflation-fears.

However, when we dig deeper, are Wall Street traders truly concerned about real, sustained inflation?

The answer might surprise you.

Today, we turn to our technical experts, John Jagerson and Wade Hansen of Strategic Trader, for a closer look at how traders are responding to inflation data – and what it means about their expectations for the future.

For newer Digest readers, Strategic Trader is InvestorPlace’s premier trading service. It combines options, insightful technical and fundamental analysis, and market history to trade the markets, whether they’re up, down, or sideways.

In Wednesday’s update, John and Wade suggested that while traders are expecting short-term inflation pressures, they’re showing surprisingly little concern for longer-term inflation risks.


Let’s turn it over to John and Wade to find out.

Have a good weekend,

Jeff Remsburg

Is a Surprise Price Jump Bullish or Bearish?

By John Jagerson and Wade Hansen

The Labor Department shocked Wall Street this morning when it announced the Consumer Price Index (CPI) jumped 4.2% since last April.

Nobody was surprised that prices went up year-over-year. After all, we are in the middle of a massive post-pandemic economic boom, and prices were falling last year as the economy shut down.

It was the size of the jump that caught many off-guard. Analysts were only expecting an increase of 3.6%.

Why is this important? One word: Inflation.

Wall Street is worried that if inflation continues to increase over the long term, the Federal Reserve will have to react by raising interest rates, which would likely throw a wet blanket on future economic growth.

Here’s the thing… Economic announcements are notoriously tricky to evaluate because a surprise to the upside, or the downside, one month doesn’t necessarily mean the longer-term trend is going to move in that direction.

Traders will typically wait for confirmation from the next announcement before reacting and making drastic changes to their outlook. They want to be sure they are reacting to a change in the long-term trend, not a blip in the numbers.

At this point, it looks like most traders are making knee-jerk reactions to this news by moving prices, but we think they are still likely viewing this surprise increase in prices as a blip rather than a change in the long-term trend.

They expect higher inflation for a few months as the economy picks back up, but they don’t expect inflationary pressure to last.

Even the Fed’s vice chairman, Richard Clarida, agrees. “These one-time increases in prices are likely to have only transitory effects on underlying inflation, and I expect inflation to return to – or perhaps run somewhat above – our 2% longer-run goal in 2022 and 2023,” he said.

Why do we think traders are reacting today but are likely treating this surprise as just a blip? The divergence between the 10-year Treasury Yield (TNX) and the Fed Funds futures contracts.

10-Year Treasury Yield (TNX)

In our April 7 Update, “Risk Indicators Favor Large-Caps and Income,” we discussed a few risk indicators that were showing signs that bullish momentum could be weakening.

The indicator we discussed that is most related to today’s news is the 10-year Treasury Yield (TNX). It has been a good barometer for how concerned traders are that inflationary pressures are rising.

As you can see in Fig. 1, the TNX broke above its down-trending resistance level today. This level has served as the top of the indicator’s short-term consolidation range since early April.

Fig. 1 – Daily Chart of the 10-year Treasury Yield (TNX) – Chart Source: TradingView

This tells us that traders are worried about inflation in the short term and are demanding a higher yield on their Treasury trades to protect them from that potential risk.

However, the TNX still has a little further to go before it even reaches its recent 52-week high of 1.77%, and it still has a long way to go before it reaches its next milestone at 2%.

So, now we know traders are making some short-term price corrections. But how are they adjusting their longer-term expectations?

It turns out, they aren’t really.

Fed Funds Futures Contracts

We can gauge market expectations for when and how quickly the Federal Open Market Committee (FOMC) will be raising interest rates in the future by tracking Fed Funds futures contracts.

Traders use 30-day Federal Funds futures contracts to hedge against, or speculate on, potential changes in the FOMC’s monetary policy. If they think the Fed is going to raise rates, they push the price of the futures contracts lower. If they think the Fed is going to cut rates, they push the price of the futures contracts higher.

You can see what traders believe the average daily effective Federal Funds rate is going to be for the month by subtracting the price of the contract from 100.

Our favorite way to track Fed Funds futures contracts is with the CME FedWatch Tool. This tool shows you the probabilities of an FOMC rate hike, or rate cut, that traders are pricing into Fed Funds futures contracts.

Looking at the estimates for where the FOMC is going to set interest rates at its December 2021 meeting (see Fig. 2), you can see that trader expectations haven’t changed a lot during the past month.

Fig. 2 – Expectations of a Rate Hike in December 2021 – Chart Source: CME FedWatch Tool

Here’s how you should read this chart:

1. The current Federal Funds target rate is 0-25 basis points (bps), or 0.00%-0.25%.
2. The Fed could increase its target rate by 25 bps to a range of 0.25%-0.50% by December.
3. The Fed could also increase its target rate by 50 bps to a range of 0.50%-0.75% by December.
4. However, traders believe there is a 91% chance the Fed is going to leave rates unchanged through December. This is a slightly higher percentage than the…
5. 89.7% chance traders had priced in one month ago.

In other words, even after today’s CPI surprise, traders still don’t think the Fed is going to raise interest rates anytime soon.

The Bottom Line

We fully expect to see increased volatility, both bearish and bullish, for the next few weeks.

We’ll likely be looking to take profits off the table a little faster when they appear, but we don’t think we need to abandon our longer-term bullish outlook.


John Jagerson and Wade Hansen

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