Investors brace for more swings as US inflation specter rises
NEW YORK (Reuters) – The inflation bogeyman has reared its ugly head and sent US stock investors racing for the hills in recent days.
This week, coming off one of the most volatile stretches in years, two important readings on US inflation could help determine whether the stock market begins to settle or if another bout of volatility is in store. If the January’s US consumer price index due this Wednesday from the US Labor Department, and the producer price index the next day, come in higher than the market anticipates, brace for more selling and gyrations for stocks.
US consumer prices rose 2.1% yearon-year in December and are forecast to stay around that pace this month.
“If we get a hot CPI print, it will insert additional uncertainty. But if we get a quiet, below-consensus print, you may see yields down and equities rally,” said Jason Ware, the chief investment officer and chief economist at Albion Financial Group in Salt Lake City, Utah.
The equity market has become highly sensitive to inflation this month. A sell-off in US stocks early last week was in large part sparked by the February 2 monthly US employment report that showed the largest year-on-year increase in average hourly earnings since June 2009.
Recent US tax cuts that may spur economic growth, the prospect of more government borrowing to fund a widening fiscal deficit and rising wages have all pushed up benchmark US Treasury yields to near four-year highs.
The jump in wage inflation pushed yields on the benchmark 10-year US Treasury note closer to the 3.0% mark last seen four years ago, denting the attractiveness of equities and unnerving investors who are fearful inflation will force the US Federal Reserve to raises short-term interest rates at a faster pace than is currently priced into the market.
The current earnings yield for the S&P 500 index companies stands at 5.4%, below the 6.4% average of the past 20 years. As bond yields rise, the spread between the two narrows, prompting asset-allocation changes between equities and fixed income.
Investor concerns over inflation were reflected in Lipper funds data last Thursday, which showed US-based inflation-protected bond funds attracted $859 million over the weekly period, the largest inflows since November 2016.
On Thursday, New York Federal Reserve President William Dudley said the central bank’s forecast of three rate hikes still seemed a “very reasonable projection.” But he added there was a potential for more, should the economy look stronger.
Traders are currently putting the chances of a 25-basis-point hike by the Fed at its March meeting at 84.5%, according to Thomson Reuters data.
Benchmark 10-year note yields last week rose to a four-year high of 2.885%. On Friday, benchmark 10-year notes fell 1/32 in price to yield 2.853%.
While many analysts were predicting bond yields to rise this year as global economies improve, the suddenness of the move was a large factor in the recent stock-market sell-off.
The 10-day correlation between the S&P 500 index and yields on the 10-year note was at a negative-0.79, as of late Thursday.
On Friday, both the Dow Jones Industrial Average and S&P 500 index closed out their worst two-week performance since August 2011.
“The pace really does matter,” said Ron Temple, the head of US equities and cohead of multi-asset investing at Lazard Asset Management in New York. “If we see 3.0% [this] week, that is going to spook people more. The equity-market psyche is fragile at this point.”
The fragile investor psyche is likely to lead to continued volatility coming off a week that saw the Dow suffer its largest intraday index point decline in history on Monday, nearly 1,600 points. The Dow currently has an average intraday swing over the past 50 days of 265.76 points, the highest since March 2016.
While volatility has subsided a little from the heights touched early last week, it is far from an all clear, said Nigol Koulajian, the chief executive of Quest Partners, a New York-based systematic commodity-trading adviser with $1.4 billion in assets under management.
He pointed to the fixed-income market as the main catalyst right now for near-term moves in the stock market.
“Investors need to keep a very, very close eye on fixed income,” Koulajian said. “The catalyst needn’t be big. When the market is this levered, even tiny events can trigger a big avalanche.”
But analysts also caution yields are not at levels that should be alarming to investors, and in fact are at levels that signal a healthier global economy, and the performance of some stocks last week points to a belief the consumer is also getting healthier.
The average yield on the 10-year Treasury note over the past 30 years is 4.834%, still well above current levels.
“Fundamentals are still positive, there is strong economic growth and strong earnings growth – those will help stocks move higher over time,” said Kate Warne, an investment strategist at Edward Jones in St. Louis. “But it doesn’t do much for predicting short-term moves.”
‘If we see 3.0% [this] week, that is going to spook people more. The equity-market psyche is fragile at this point’