NEW YORK (CNN/Money) -
Now that investors believe higher interest rates are on the way, the only thing left to do is wonder about how far and how fast rates will go.
The key to that is how far and how fast inflation will go, and the coming week will bring data that could go a ways toward solving that mystery.
Investors worried about higher rates dumped stocks Friday, pulling the major gauges lower for the week. (For a full wrapup of how the market fared, click here). Bond prices also got hammered, pushing the yield on the 10-year Treasury to 4.77 percent, the highest in nearly two years.
Next Wednesday morning brings news of import and export prices, and Thursday the PPI, which measures inflation at the wholesale level. But the biggest number will come on Friday, when the Bureau of Labor Statistics issues its consumer price index (CPI) for the month of April. Economists, on average, think CPI rose 0.3 percent last month, a slowdown from March's 0.5-percent surge, according to Briefing.com.
The "core" CPI, which excludes volatile food and energy prices, is expected to rise 0.2 percent, compared with a 0.4-percent gain in March. [For a line-up of key events next week, click here]
If these numbers are much higher than expected, then the bond market -- which already expects the Fed to start raising rates in June -- could start pricing in more aggressive Fed tightening measures.
And the funny thing about inflation is that it's something of a self-fulfilling prophecy -- if people think inflation is going to rise, then they're more willing to raise their own prices, which pushes inflation higher, etc., etc. Big numbers on CPI could help set such a cycle in motion.
"When businesses begin to believe that others are raising prices, they raise prices, too," said Anthony Crescenzi, bond market strategist at Miller Tabak & Co. "That will have to be arrested [by the Fed], and the only way to do it is sooner rather than later."
Inflation expectations are already on the rise, Lehman Brothers economist John Shin pointed out in a note on Friday, citing two key measures:
- The University of Michigan asks consumers about inflation every month, and that survey's inflation-expectations gauge is at its highest level since last April.
- The difference in yields between Treasury Inflation Protected Securities (TIPS) and the 10-year Treasury note has been climbing steadily for months, nearing all-time highs.
Many Fed policy makers and other economists have long believed that inflation is in check, thanks to the economic "slack" of a relatively high unemployment rate and low factory use. Labor costs are the biggest components of inflation, and they've been growing anemically in recent years.
But few would deny that prices for food, energy and health care -- among other things -- are rising, and there have been recent signs of robust strength in the labor market. If the "headline" inflation numbers such as CPI start flashing red, then inflation expectations will also rise, and workers might start expecting higher wages to keep up, Shin said.
"We feel that such a possibility is still a long way off, but it is a development that bears watching," Shin wrote.
Cisco headlines slim earnings roster
The quarterly earnings season is winding down, but this week will bring a few closely watched reports.
Tuesday afternoon, after the closing bell, telecom equipment maker Cisco Systems (CSCO: Research, Estimates) reports its earnings for its fiscal third quarter. Analysts, on average, expect Cisco to report earnings of 18 cents a share, compared with 15 cents a year ago, according to earnings tracker First Call.
In February, Cisco's second-quarter results beat Wall Street estimates, but they weren't strong enough to satisfy finicky traders, who'd been hoping for even more, and the stock sold off. In fact, Cisco shares have been falling most of the year, along with the rest of the Nasdaq. Investors will be looking to Cisco for signs that business demand for tech equipment will be robust this year.
Wednesday afternoon after the bell, Walt Disney (DIS: Research, Estimates) reports on earnings in its fiscal second quarter. Analysts, on average, expect Disney to report earnings of 21 cents a share, compared with 11 cents a year ago.
Several retailers report earnings Thursday before the bell, including the world's biggest merchant, Wal-Mart (WMT: Research, Estimates), along with Target (TGT: Research, Estimates), Tiffany (TIF: Research, Estimates) and others. Analysts, on average, expect Wal-Mart to report earnings of 49 cents a share, up from 42 cents a year ago.
Personal computer maker Dell (DELL: Research, Estimates) reports its first-quarter results Thursday after the bell. Analysts, on average, expect Dell to report earnings of 28 cents a share, up from 23 cents a year ago.
Other key events in the week ahead:
- Tuesday afternoon, Philadelphia Fed President Anthony Santomero and Chicago Fed President Michael Moskow will speak about the prospects for the U.S. economy.
- On Wednesday morning, the Commerce Department releases figures for the balance of trade in March. Economists, on average, expect the deficit to swell to $42.6 billion from $42.1 billion in February, according to Briefing.com.
- Also on Wednesday, the Treasury Department reports its budget figures for April. Economists, on average, expect the budget to shrink to $46.8 billion from $51.1 billion in March.
- Thursday morning will bring the Commerce Department's report on retail sales in April. Economists, on average, expect sales to rise just 0.1 percent, compared with 1.8 percent in March.
- Thursday morning the Labor Department releases the Producer Price Index, a measure of inflation at the wholesale level. It is expected to rise 0.3 percent after a 0.5-percent rise in March. Excluding food and energy prices, "core" PPI is expected to gain 0.2 percent, matching March's gain.
- On Friday, the Bureau of Labor Statistics issues its consumer price index (CPI) for the month of April. Economists, on average, think CPI rose 0.3 percent last month, a slowdown from March's 0.5-percent surge. "Core" CPI, which excludes volatile food and energy prices, is expected to rise 0.2 percent, compared with a 0.4-percent gain in March.
- Also on Friday, the Fed will release its figures for industrial production in April. Economists, on average, expect production to rise 0.5 percent, compared with a decline of 0.2 percent in March.
- Friday morning will also bring the University of Michigan's closely watched measure of consumer sentiment in May. Economists expect this preliminary index to rise to 96.5 from 94.2 in April.