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The stock and bond markets have been reintroduced to volatility. Frankly, it was long overdue, even if most investors simply do not enjoy those “whoosh” sounds of dead air when the market drops rapidly. While volatility has been one force, the ultimate fundamental driving force that stoked the volatility’s ability to rise was a return of higher wages, higher interest rates and ultimately the fears of higher inflation. And there is the concern that reluctant bond buyers are going to have to absorb more Treasury notes from the Federal Reserve now that it started unwinding its massive $4.5 trillion balance sheet.

On Wednesday, February 14, the markets are going to get a look at January’s Consumer Price Index (CPI). This is the direct measure of consumer inflation. After everything we have seen thus far, investors and economists better expect that the inflation reading will be hotter than normal. They also likely already are bracing for the financial media to be talking about whether the Federal Reserve is behind the curve on raising interest rates.

Bloomberg’s consensus estimate on the headline all-items CPI is 0.3%, and 0.2% on the core CPI reading, which excludes energy and food. Dow Jones consensus estimates call for a 0.4% gain on the headline CPI and up 0.2% on the core CPI.

The annualized year-over-year gains in consumer prices are the ultimate measure of annualized inflation. These consensus estimates were projected by Bloomberg to be 2.0% on the headline CPI and 1.7% on the core CPI. Dow Jones called for a 1.9% annualized headline CPI reading and a 1.7% annualized gain in core CPI.

What should stand out is that inflationary pressure through January were simply stronger than they have been in some time. We have seen ISM and other business forecasts all pointing to higher wages and stronger prices. Companies have said that transportation costs were up due to higher gas prices and wages, and all the wage increases and one-time bonuses that companies have handed out on the heels of tax reform have to add up to higher wages.

For a comparison to the prior month, the preliminary readings from December were as follows:

• Headline CPI monthly change +0.1%
• Core CPI monthly change +0.3%
• Headline CPI year-over-year change +2.1%
• Core CPI year over-year-change +1.8%

Investors are now reconsidering how they should position their portfolios for 2018 as higher wages, interest rates and even inflation concerns are being countered by tax reform, accelerated corporate earnings and stronger growth of gross domestic product (GDP). At some point, they all have to lead to higher inflation, or so the economic theorists would say.

The real question to consider is how markets will react if and when they get a higher inflation number. If annualized prices are well over 2% on the core CPI reading, then there is more ammunition for the Fed to deliver on more interest rate hikes. That being said, the Fed under newly appointed Chair Jerome Powell probably still would rather deal with a few rounds of above-trend inflation than raise rates too fast and kill the big growth ambitions of 3.0% in GDP.

Perhaps the largest issue that is not given much attention is that the stock market and bond market might both love it if the inflation barometer simply does not tick that much higher.

The current climate seems to be returning to a market in which news is not really being priced in all that much until it actually occurs. That will drive “efficient market” theorists nuts if it lasts for too long, but frankly we endured years when the markets were just atrocious at being a good preliminary judge on what the outcome should be versus expectations.