Inflation Forecasting from Cross-Sectional Stocks

This paper examines the inflation forecastability of cross-sectional stocks. To differentiate the cross-sectional inflation exposures, we make the important observation that cross-sectional stock returns exhibit persistent sensitivity to headline inflation shocks during the calendar month of CPI, and to core inflation news on CPI announcement days. Examining the relative pricing between stocks with high- and low-inflation exposures, captured either by the headline- or core-focused inflation beta, we find active price discovery on inflation and its core component in cross-sectional stocks. The corefocused forecasting portfolio emerges as a unique and unparalleled predictor for core inflation, especially during the inflation surge of 2021 and 1973, when its predictive power and economic significance increase dramatically. Moreover, our stock-based predictors can uniquely forecast the foresting errors made by economists, especially during 2021-22, and its predictability is especially strong under Fed’s QE and when the Fed is behind-the-curve in fighting inflation.