Investors await US inflation data
new york — 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 January’s US consumer price index due this Wednesday from the US Labour 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 per cent year on year in December and is 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, 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 selloff in US stocks earlier last week was in large part sparked by the February 2 monthly US employment report which 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.
“This is how we started, go back to Friday and this is exactly where we were,” said Art Hogan, chief market strategist at B. Riley FBR in New York. “The conversation about equity risk premium, interest rates and inflation, we are coming full circle.”
The jump in wage inflation pushed yields on the benchmark 10-year US Treasury note closer to the 3 per cent mark last seen four years ago, denting the attractiveness of equities, and unnerving investors 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 per cent, below the 6.4 per cent 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 was reflected in Lipper funds data on Thursday, which showed USbased 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 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 per cent, according to Thomson Reuters data.
Benchmark 10-year note yields rose as high as 2.884 per cent on Thursday, just below Monday’s four-year high of 2.885 per cent. The notes ended down 6/32 in price to yield 2.853 per cent.
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 selloff.
The 10-day correlation between the S&P 500 index and yields on the 10-year note stands at a negative 0.79.
Both the Dow Jones Industrial Average and S&P 500 index were on track on Thursday for their biggest two-week percentage declines since August 2011.
“The pace really does matter,” said Ron Temple, head of US Equities and co-head of multi asset investing at Lazard Asset Management in New York.
“If we see 3 per cent next 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 earlier last week, it is far from an all clear, Nigol Koulajian, chief executive of Quest Partners, a New York-based systematic commodity trading advisor with $1.4 billion in assets under management, said. — Reuters