Inflation Reality Is About to Hit a Market Riding on Shaky Hope

Inflation Pressures

The S&P 500 moved higher for the seventh straight session Thursday on shaky hope that the ceasefire agreement with Iran would hold and lead to productive negotiations this weekend.

Oil prices have rebounded from the lows hit on Wednesday, which illustrates a high level of skepticism about how easily the oil supply issue will be resolved.

The Ceasefire Math

While there are a number of ways for the uneasy truce to fall apart, and Iran remains belligerent in public, there is obviously a private desire to reach some sort of agreement. It won't be easy, but the threat of further U.S. military action is significant and the Islamabad talks this weekend will be the first real test of whether both sides are serious.

The CPI Report

While investors wait for news on negotiations this weekend, the March CPI report will be released at 8:30 a.m. ET this morning. This is the first inflation reading to fully reflect the Iran war's impact on energy prices.

Headline CPI is expected to rise 0.8% to 0.9% month over month and 3.1% to 3.7% year over year, a sharp increase from February's 2.4% reading. Core CPI, which strips out food and energy, is forecast to rise a more modest 0.2% to 0.3% monthly. The wide range of estimates reflects the volatility caused by the war.

The year-over-year headline number is the one to watch. If March comes in at 3.4% as expected, it would be the largest year-over-year increase since April 2024. Anything above 3.5% is going to hit the bond market hard and push yields higher.

The Issue the Market Has Been Ignoring

The most dangerous financial fallout from the Iran situation has always been inflation, but the market has been ignoring it for the past week. The primary focus has been on the ceasefire agreement. Continued strength in oil has been ignored by equities because traders have been trying so hard to get in front of progress with Iran. Everyone wants to be long before a peace agreement is signed.

The problem investors will eventually have to confront is that, even if a deal with Iran is made, the disruption to the oil market will have a long-lasting impact. So much damage has been done to the oil supply chain that it cannot be fixed simply by reopening the Strait of Hormuz. It will take months and possibly years to rebuild some of the damaged infrastructure.

If oil prices continue to stay sticky to the upside, it is going to drive inflation above 3% and keep interest rates elevated. That is a headwind that will persist even after the Iran situation is fully settled.

My Game Plan

Since it is Friday and it has been a good week, there may be an inclination to take some profits ahead of the elevated risk of bad news over the weekend. A hot CPI print this morning will be a convenient excuse to sell.

I have already raised some cash this week, and I don't expect to be a buyer today. I like the chart development I'm seeing, but sentiment is feeling a little too positive given the inflation risk we are facing.

At the time of publication, Rev Shark had no positions in any securities mentioned.