US inflation fears trigger Wall St sell-off
Dow Jones tumbles and bond yields spike as better than expected jobs data wrong-foot investors
WAGES in the United States are rising at the fastest pace since the Great Recession and the American economy is moving into a full-fledged boom, sending bond yields soaring, stocks plunging and raising the spectre of shock tightening by the US Federal Reserve.
Global investors were caught off guard after US jobs growth reached 200,000 in January and pay rises spiked more than expected to 2.9pc. A report by the US small business lobby this week said that more firms plan to raise wages than at any time since 1989.
It is the clearest signal to date that the labour market is tightening and that the US “Phillips Curve” is coming back to life after years of stagnation, seemingly afflicted by a “mystery virus”.
Economists fear that the Trump administration’s blast of fiscal stimulus at this late stage of the cycle will lead to overheating and force the Fed to accelerate the pace of interest rates.
Yields on 10-year US Treasuries – the world’s benchmark price of money – jumped 7 basis points to a four-year high of 2.85pc yesterday as inflation fears crystallised. They are reaching levels that are starting to nudge up mortgage rates and squeeze borrowers, with the first minor tremors already hitting US corporate bond markets.
The US Treasury’s watchdog (OFR) recently warned that a 100 basis point rate rise in yields would slash $1.2 trillion of value from the Barclays US Aggregate Bond Index, with further losses for junk bonds and derivatives. They have risen 60 points since mid-october. The OFR said the damage could dwarf the “bond massacre” in 1994.
The Atlanta Fed’s instant tracker of GDP growth has jumped to a stunning 5.4pc as private investment picks up. It comes even before the pay cheques reflecting the Trump tax cuts start to reach workers, lifting take-home earnings for 90pc of taxpayers. “It looks more and more likely that we will have to revise up our call for three Fed rate hikes this year to four,” said James Knightley from ING.
“People have been really complacent about the Fed. The economy is booming and core inflation is going to pick up from March onwards. I think this is potentially more dangerous for markets than the sell-offs in 2013 and 2016,” said Marc Ostwald from ADM.
Higher growth in the world’s biggest economy is a double-edged sword for investors at a time when the US output gap has already closed and capacity constraints are building up across the US economy. The concern is that the monetary regime is moving into a new phase, threatening the “Goldilocks” climate once so propitious for equities.
On Wall Street, the Dow fell 666 points, or 2.5pc, yesterday, while the German DAX was off 1.7pc. There are signs that the US dollar may have stabilised following a deep slide over the last year, with the dollar index rising to $89.25. A sustained dollar recovery would tend to squeeze the vast offshore dollar funding market and drain global liquidity.
The nagging worry is what will happen to record US equities if inflation picks up dramatically, as it did in similar circumstances in the mid-sixties, and forces the Fed to slam on the brakes. Stocks are currently valued higher than just before the 1929 crash if measured by the Shiller cyclically adjusted price-to-earnings ratio.
The OFR report said they are in the “97th percentile relative to the last 130 years”, with margin debt an all-time high and “covenant-lite” bond contracts with minimal protection running at 51pc of all issuance.
Bank of America issued a sell alert late Wednesday, warning its “Bull Bear” indicator of investor over-optimism had reached a red extreme and hedge funds were piling into risk assets. Cash allocation had hit multi-decade lows. The sellsignal has foretold 11 stock market slides since 2002 with no false alarms. The bank expects a 4pc correction in the S&P 500. The longer term “Icarus rally” is not yet over, but risks are mounting.