Will US CPI Signal Start of Inflation?

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Equities march higher
EU inflation below forecast
Nikkei 0.41% Dax -0.11%
UST 10Y 0.66
Oil $42
Gold $1932/oz
BTCUSD $11447

Asia and the EU
EUR CPI 0.8% vs. 0.9%

North America Open
USD CPI 8:30

Its been another night of risk on trades with equities firmly up by more than 50 basis points while high beta currencies rose as well.

The newsflow was very quiet with no progress in Washington on stimulus talks and little economic releases elsewhere but markets remained in a positive mood betting on the fact that the worst of COVID induced slowdown was behind us and that the economy was going to rebound strongly into the end of the year.

On the eco front FX traders saw the RBNZ statement in early Asia dealing which suggested that the central bank may be comfortable with the notion of negative interest rates. The bank noted, “Reflecting a possible need for further monetary stimulus, the Committee also agreed that a package of additional monetary instruments must remain in active preparation. The deployment of such tools will depend on the outlook for inflation and employment. The package of further instruments includes a negative OCR supported by funding retail banks directly at near-OCR (a Funding for Lending Programme). Purchases of foreign assets also remain an option.”

The news instantly sent kiwi plunging about 50 pips, but the news reaction set the lows for the session and the single currency ground its way higher the rest of the night. Part of the reason for the rebound was simply supportive equity flows, but the market also remains skeptical that any such radical policy move by the RBNZ is imminent. Rather it appears that New Zealand’s monetary authorities are simply testing the water to prepare the market for such possible action should conditions deteriorate markedly. For now, the country remains one of the better performing advanced economies in the post-COVID world.

In North America today the market will get a look at US CPI data which is expected to print at 0.2% vs. 0.2% prior but there is a chance that it may print hotter given the upside reading in yesterday’s PPI data. Whether inflation is picking up due to COVID supply constraints or due to fiscal and monetary expansion remains to be seen, but bonds have certainly started to respond to the higher price level pressures with yields up 7 basis points in the past few days.

For now, the rise in yields has not impacted stocks but if bonds begin to selloff further the pressure on stocks will begin to mount from every angle as cost of capital will rise, bond losses could cause margin liquidations and asset rebalancing across the board and P/E multiples could compress in a higher rate environment.

It may take a while to take notice of these new dynamics but if inflation becomes the new economic reality, the upside for stocks will become progressively more difficult.

Boris Schlossberg
Managing Director

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