Month: January 2022

Inflation and US interest rate expectations dominate markets

Inflation and the likely response from the US Federal Reserve (Fed) dominated markets this week, as Jay Powell, the chair of the Fed, said the inflation outlook had worsened since their December meeting, whilst not ruling out raising rates at every policy meeting for the rest of the year. Fourth-quarter US GDP came in higher than forecasted at 6.9% annualised. Volatility in the US market picked up appreciably, with the VIX index currently trading at 31, well above its long-term average of around 20. On Monday alone, US equities traded down by over 3%, before closing up 1.2% on the day, 4.4% higher from its low point. Volatility of this magnitude has not been seen since March of 2020, at the point Covid-19 was declared a pandemic. US technology stocks have now fallen over 16% since the November record high. The latest US inflation data is due out at 1.30pm today, London time, with forecasts pointing towards year-on-year inflation coming in at 5.8%. How markets react to this data will likely define their tone in the coming weeks, all else being equal. Although most economists expect US inflation to peak this year, that is not forecast for another couple of months. However, investors were reminded this week that not all technology stocks are speculative, with robust earnings and profits figures released from both Microsoft and Apple.

Equities fall with technology stocks bearing the brunt of the pain

As of 12pm on Friday, London time, US equities fell 1.6% over the week, whilst US technology stocks dropped 3.0%. As the selloff became broader, European stocks lost 2.3%, although the UK’s stock market, being heavily exposed to so-called ‘old economy’ sectors such as energy and financials, was relatively defensive, falling 0.8%. The Japanese market fell 2.6%, as did Australian stocks, whilst the emerging markets dropped 4.2% having been relatively defensive year to date, succumbing to a sharp upwards move in the US dollar.

Government bond yields rise back up towards their recent highs

10-year US Treasury yields, which move inversely to price, traded back up towards their recent highs, now trading at 1.84%. It was a similar story for other developed market bonds, with German bund yields rising to -0.02% and UK gilts to 1.28%. The US dollar index moved sharply higher this week, trading up 1.8%, now priced at $1.11 versus the Euro and $1.34 versus Sterling.

A mixed week for commodities, with gold falling, whilst oil continued its steady rise

It was a mixed picture within commodity markets, with gold falling 2.6% to $1,787 an ounce as expectations of rising US interest rates are priced into the market. Copper also fell, losing 3.8% over the week, now trading at $9,836, whilst iron ore rose over 6% over the week. Crude oil also rose, with Brent and US WTI (West Texas Intermediate) both rising by over 2.5%, trading at $90.2 and $87.3 a barrel respectively.

Issues under discussion

Strategists adopt a hawkish tone in respect of US interest rates

Both the Fed and market strategists have adopted a much more hawkish tone in respect of US interest rates in recent weeks. The Fed has committed to remain data-dependent as it adjusts to heightened levels of inflation, but nonetheless, it may be that they choose to front end load any rate rises this year to get ahead of the inflation narrative. Therefore, whilst expectations are for four quarters of a point rate increases, half a percent increases cannot be dismissed, depending on what the inflation data looks like between now and the Fed’s March rate-setting meeting.

Markets are going through a period of rebalancing, as investors must contend with inflationary pressures for the first time in many years. Those companies on high valuations with profits due to come through in later years are bearing the brunt of the pain. However, although growth is expected to slow versus last year’s high bar, it is still forecast to be a robust year for earnings, with both households and corporates sitting on cash built up during the pandemic. Stock market returns can still finish the year in positive territory despite the tough start. Volatility is likely to remain elevated, but opportunities to pick up stocks at more attractive levels may present themselves as markets work their way through this period of adjustment.

US technology stocks suffer a correction as bond yields surge

US Treasury yields backed up sharply this week as investors priced in further rate hikes by the Federal Reserve in response to rising inflation, with the consumer price index having recorded a 7% rise last year. This led to a further sell-off in growth and technology stocks, with the latter having fallen close to 12% since their peak last November. Many of the poster child beneficiaries of the pandemic have experienced some of the heaviest falls, with Netflix, the online streaming television service having fallen over 25% since its high. Peloton, the manufacturer of exercise bikes and online cycling classes has dropped over 30% year to date and a massive 85% since its all-time high in January of last year. The weakness in share prices has been more broadly spread this week, not helped by results from Goldman Sachs which highlighted a huge increase in expenses, rising by 33% over the year, largely due to higher wage demands. However, the investment bank still achieved a net profit of the year of $21.2bn, more than double the level achieved in 2020 and its highest on record.

Monetary policy easing in China as growth falls to its lowest level in 18 months

On Monday, China’s National Bureau of Statistics revealed that the Chinese economy had expanded by 4% year on year in the fourth quarter, its slowest rate of growth for eighteen months, but ahead of forecasts. On the same day, the People’s Bank of China cut rate interest rates on one year lending facilities to 2.85%, whilst on Thursday, the mortgage lending rate was lowered for the first time in nearly two years. The five-year prime rate was lowered to 4.6% and the one-year rate cut to 3.7%. This reminded investors that monetary policy across the globe could be increasingly divergent this year due to contrasting rates of growth and inflation.

Broad sell-off in equities, with technology and growth stocks suffering the most

As of 12pm London time on Friday, US equities fell 3.9% over the week, whilst the US technology sector lost 5.0%. European and UK stocks, less highly valued and with a greater exposure to economically sensitive sectors fell 1.1% and 0.6% respectively. Japanese equities fell 2.6%, although the Yen rallied by over 1% versus most major currencies, cushioning the fall for overseas investors. Australian equities fell 3.0%, whilst emerging markets only lost 0.1%. Emerging markets were supported by Hong Kong stocks which rose 2.4% on the back of Chinese monetary easing, and Brazil, which increased by 2.0%, boosted by strong oil prices.

10-year US Treasury yields hit 1.9% mid-week

10-year US Treasury yields, which move inversely to price, rose to 1.9%, before dropping back to 1.78% by Friday, benefitting from risk aversion in stock markets due to inflationary concerns, and an increasingly belligerent Russia in respect of a build up of armed forces on the Ukrainian border. German yields briefly rose into positive territory for the first time in over two years, touching 0.02%, before settling back down to -0.06%. UK gilts touched 1.28% mid-week, now trading back down at 1.19%.

Metals and energy prices rise

Gold rose 1.0%, currently priced at $1,837 an ounce. Whilst industrial metals also rose, with copper trading up 2% to back over $10,000 and iron ore responding positively to Chinese monetary easing, rising over 8%. Brent crude traded above $89 a barrel for the first time in over seven years, before falling back down to $87.2 on Friday

US inflation hits a near 40-year peak

Despite a brief rally intra week, growth stocks, led by technology, continued to sell off this week as the latest inflation data for the US, as represented by the consumer price index, continued to rise. The index rose 7% for the year to the end of December, its fastest pace of increase for almost forty years. Whilst this was in line with market expectations, the figure for the month of December exceeded forecasts, coming in at 0.6%. To further confirm the inflationary picture, the latest Producers Prices Index, which measures prices that producers receive for their finished goods, increased by 9.7% for the year.

The yield on 10-year US Treasuries, having touched 1.8% on Monday, has now moderated to 1.74%, but remains sharply higher than one month ago when it was trading beneath 1.40%. The market is currently pricing in four US interest rises this year, with the first hike expected in March, taking the Fed funds rate to 1% if this is borne out. Futures markets are also pointing towards moderating inflation, and with several rate hikes already priced in, the US dollar actually weakened this week despite the strong inflation data, providing a much-needed fillip to emerging markets.

As of 12pm London time on Friday, US stocks fell 0.4% over the week whilst US technology stocks declined by 0.9%, taking them down almost 8% since their peak last November. European equities lost 0.8%, whilst the more economically sensitive UK market rose 0.4%. Japanese equities gave up 0.9%, and Australian stocks similarly fell 0.9%, whilst emerging markets rose 3.0% with Latin America rising 4.6%. At a broad sector level globally, it was energy, materials and financials that led the way, whilst technology was the notable laggard.

Government bond yields in Germany and the UK also moderated this week, with the 10-year bund now trading at -0.07% and UK gilts 1.13%, whilst both being sharply up versus one month ago.

Gold rose 1.3% to $1,821 an ounce, with copper rising by just over 2% and Brent crude oil up over 4%, priced at $85.2 a barrel.

Issues under discussion

Inflationary numbers continue to climb

Whilst inflationary numbers continue to climb to new highs, there is at least some consensus that inflation will peak this year, probably by the summer for the US economy and earlier for Europe. However, thereafter is where the divergence in views become stark. Those on the transitory side of the debate expect inflation to fall to levels closer to what we had become accustomed to pre-pandemic, whilst those on the inflationary side believe inflation will remain at levels close to 4% or 5% in the US. The latter view would leave the Fed still having to do a lot of heavy lifting if interest rates have only reached 1%, whilst the former view may see less than four rate rises if the Fed interprets a drop in inflation as transitory, even if it is too early to call.

Bond yields jump as fears over Omicron recede

Global equity markets have started the New Year on a weak footing as fears over the economic impact of the Omicron covid variant have receded, leading to a sharp increase in bond yields as expectations of monetary tightening rise to combat inflationary pressures. In what feels like a repeat of January last year, the 10-year US Treasury yield has jumped up from 1.51% to 1.73% in a matter of days, sending richly priced growth stocks downwards, whilst the energy and banking sectors have enjoyed a strong rally, building on their recovery from last year. Later today the latest US non-farm payrolls are released, with expectations that 400,000 new jobs were created in December. If this proves to be close to the mark, this will reinforce expectations for sooner monetary tightening from the US Federal Reserve.

As of 12pm London time on Friday, US equities had fallen 1.5% over the week, whilst US technology stocks were down 3.6%. European equities were down 0.2%, whilst UK stocks, which have a greater weighting towards financials and energy, were up 0.5%. The Japanese market rose 0.2%, whilst Australian equities gained 0.1%. Emerging markets fell 1.2% with a large divergence of returns at a country level, with Indian stocks rising 2.6%, whilst domestic Chinese stocks fell 1.7%.

Following on the heels of US Treasuries, the yield on 10-year German bund, which moves inversely to price, rose to -0.06%, reaching the highest level since May 2019. The latest European inflation numbers were released today, with the latest consumer prices index for December coming in higher than forecasted at 5.0% for the year. A number of commentators have begun to forecast this number to rollover in the coming months, therefore it is definitely one to watch out for. The 10-year UK gilt yield also rose to 1.15%, with the Bank of England having already raised interest rates from 0.1% to 0.25% in December.

Crude oil has risen by over 6%

Crude oil has risen by over 6% in the first week of the year, as traders price in higher demand as fears of Omicron wane. Brent crude is currently trading at $82.8 a barrel, whilst US WTI (West Texas Intermediate) is trading at $80.1. Meanwhile gold fell by 2.0% as expectations of US monetary tightening grow, with the precious metal now trading at $1,792 an ounce.

Issues under discussion

Leaning into cheaper, more economically sensitive stocks, whilst keeping a foot in growth stocks

Whilst it is too early to be totally confident as to the economic impact of the omicron variant, the early signs are encouraging that whilst it is more contagious, it is indeed less virulent than previous variants, as the early indications from South Africa suggested. Therefore, the focus on investors’ minds has returned to inflation.

There are solid reasons to think that inflation may peak in the coming months, not least the fact that inflation is a year-on-year comparison and very soon we will no longer be making comparisons to a period of lockdown.