Inflation nerves return

US yields rise, boost dollar

The inflation genie I mentioned on Friday found life rather uncomfortable in its bottle, it appears, as US yields shot higher on Friday. Notably, the long end of the curve steepened markedly, and for all the noise surrounding the rise in 10-year yields, the 30-years was where the real action was.

That was enough to unwind the intra-day rallies on Wall Street, with the rotation into cyclicals at the expense of technology very much in evidence again. That left the Dow Jones higher, the Nasdaq stretchered of injured once again, and the S&P 500 left somewhere in the middle.

The US dollar duly reversed its intraday sell-off, finishing the session on a strong note. Most interestingly, from my point of view, was gold. For the first time in what seems forever, gold did not wilt in the face of Friday’s impressive leap in US yields. Gold managed to record a small gain for the session, which should be taken as a massive win given its performance this year.

Gold’s performance, and the resilience of non-tech stocks, hints that maybe markets are starting to get more comfortable with the prospects of higher inflation, and some degree of resulting adjustment in the costs of capital.

Equity markets in the Asia Pacific, ex-Mainland China, are vacillating each side of unchanged this morning after US index futures started today positively. Some very dovish comments from US Treasury Secretary Yellen over the weekend no doubt helping the process along.

China data produced a mixed bag today, giving the market no real directional nudge. Industrial Production and Retail Sales outperformed YoY, but Jan-Feb Fixed Asset Investment and Unemployment both disappointed. China’s equity markets are lower today as the government’s relentless crackdown on technology and tightening financial conditions sap investor confidence. Like the Nasdaq, the Shanghai Composite’s chart shows a market well in correction territory, and the CSI 300 continues to threaten longer-term support.

It is a heavyweight week for central banks this week. The FOMC announces its latest monetary policy decision on Wednesday. Although no Fed Funds or QE programme changes are expected, all eyes will be on the governors’ “dot plots” of future rate expectations. If those are shifted forward, something I doubt given the nervousness in markets, we could be in for another bout of inflation nerves.

In Asia, Indonesia and Taiwan announce their latest policy decisions on Thursday, with both expected to stand pat. Indonesia has probably the more interesting, having cut rates last month, just before the latest bond yield spikes and US dollar strength. The rupiah is amongst the more vulnerable regional currencies to higher US yields and dollar strength. Expect central bank intervention to sell US dollar to ramp up if the rupiah weakens this week.

The Bank of Japan announces its latest decision on Friday. We expect the very dovish tone to continue with no moves on rates. More interest will be whether the BoJ will allow JGB’s to fluctuate in a wider band given the moves in yields internationally. That may alleviate upward pressure on USD/JPY, although I suspect that will be a temporary fix.

The Bank of England also announces on Thursday. Again, rates will be left unchanged. The post-meeting statement will be of more interest as inflationary pressures rise, and the impressive speed of Covid-19 vaccinations and gradual reopenings brings the UK recovery forward. If the MPC notes these factors as worthy of consideration going forward, gilt yields could push higher, dragging sterling along with them, especially versus the euro.

With markets back on inflation watch, India’s WPI Inflation for February and its trade balance will be monitored closely. Data released late Friday showed India’s inflation rising above 5.0% yet again, while industrial production and manufacturing softened unexpectedly. Combined with rapidly rising oil prices pressuring the current account, India’s nascent recovery appears to be faltering, and it is in danger of slipping back into the stagflationary box canyon. Neither outcome will be positive for Indian bonds, or the rupee, with equities also likely to struggle.

One bright spot is the impressive rise in foreign exchange reserves to USD580 billion, now the 4th largest in the world. That will soften the blow on the current account due to energy prices. Still, if WPI Inflation and the WPI sub-indexes disappointed, the gloomy outlook for Indian assets may darken.

On the subject of inflation genies, despite Ms Yellen releasing the doves over the weekend and steadying nerves in Asia this morning, I do note that sentiment of late turns on a dime in the US right now. Last Friday’s price action highlighting this risk. Although all eyes will be on the FOMC meeting midweek, do not discount US Retail Sales’ potential fallout tomorrow night. Retail Sales are expected to fall by -0.60% MoM for February. A number above zero per cent could frazzle nerves again. US Foreign Bond Investment, and Net Long-Term Tic Flows, released in the early hours of tomorrow morning Asian time, could provoke a similar reaction.

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