US inflation continues to heat up, but markets unfazed

Yesterday’s US Consumer Price Inflation report was hotter than expected; the YoY rate of headline CPI rose to 5.0% and the Core rate to 3.8%, both above expectations and with the MoM pace of price growth for both metrics also coming in above expectations. The YoY rates continue to be distorted by weakness in price pressures in the US this time last year given the impact of the first Covid-19 lockdown, as well as the influence of resurgent demand in sectors benefitting the most from economic reopening and US government stimulus cheques. However, a number of analysts noted that there is growing evidence of rising inflation in non-reopening/stimulus cheque linked sub-sectors (like cost of shelter), which could point towards inflation remaining sticky at elevated levels in the months ahead (which seems to contradict the Fed’s argument that inflation is going to be transitory).

Nonetheless, despite the stronger than expected US inflation report, and despite evidence of inflationary pressures in the Chinese manufacturing sector earlier in the week (when factory gate prices rose to their highest since 2008), markets currently seem unfazed. The downtrend in US government bond yields (as well as in global bond yield) continued yesterday and 10-year yields are now down to under 1.45%, having started the week closer to 1.60%. On the week, US real yields are down by a similar margin; 10-year TIPS yields dropped to around -0.92% yesterday from above -0.85%, meaning yields are down about 12bps from where they started the week (close to -0.8%). Meanwhile, 10-year break-even inflation expectations remain subdued in the mid-2.30s%, down from close to 2.40% at the start of the week. Bond markets are clearly sending the signal that 1) they are growing increasingly less worried about inflation, hence subdued real yields and 2) they are confident that the Fed’s dovish, patient approach will keep US financial conditions highly accommodative for the foreseeable future (hence why real yields remain so low). Note also that yesterday’s dovish ECB outcome (the bank did not announce a slowing of its accelerated pace of PEPP purchases yesterday as some had feared) is also arguably weighing on global bond yields.

This fall in yields and inflation concerns has been a good recipe for global equity markets; a few major European equity bourses have this morning been probing record levels and US stocks are for the most part also trading at record levels after decent gains were seen during yesterday’s session. In pre-market trade, E-mini S&P 500 futures are up about 0.2% after yesterday’s 0.5% gain and trading just under 4250 (record highs), while Nasdaq 100 futures are up 0.3% after yesterday’s more than 1.0% gain with a test of the 14K level feeling imminent. Some traders have been pointing to the news that a group of bipartisan US Senators reached agreement on an infrastructure deal said to cost $1.2T over eight years, which seems to have reignited the prospect of a bipartisan deal being reached, as a positive for risk appetite in stock markets. Elsewhere, crude oil prices are a little bit firmer with WTI and Brent both still close to cycle highs despite (slightly odd) calls from the IEA in its latest monthly report for OPEC+ nations to “open the taps” given a fear of markets being undersupplied in the months ahead. Meanwhile, in precious metals, gold remains subdued around the $1890 mark, but in lieu of the recent fall in global bond yields, a move back above the $1900 does feel like it would make sense, but in the meantime, a slightly stronger US dollar this morning is blocking this from happening.

Turning now to FX markets; the global nature of the fall in bond yields (its not just US yields dropping, yields in Europe and other developed countries are also down) is insulating the US dollar from what would normally be negative impact of a fall in US real yields. In fact, the DXY is actually performing pretty well this morning and is up about 0.2% on the session around 90.20. Yesterday’s inflation data and ECB meeting seem to have failed to stir the pot meaningfully for FX markets and the DXY remains locked inside recent ranges, as does EURUSD (which is this morning just under 1.2150 but still within recent 1.2100-1.2250ish ranges) and other major USD pairs. That is means markets will be looking ahead to the next major fundamental catalyst, which comes in the form of next week’s Fed meeting. Beyond that, market commentators have been flagging the risk that it could be a very sleep summer in FX (and financial markets more broadly). On the session, things are looking mixed in G10 FX with no clear risk bias to be observed; SEK and NZD are the worst performers, down more than 0.3% on the session versus the US dollar each. EUR, JPY and CHF are each down about 0.2%. CAD, AUD and GBP are the next best performers after the US dollar, only down about 0.1% on the session each. The former two are boosted by buoyant commodity prices.

In terms of GBP; after its strong rebound from under the 1.4100 level back to the upper 1.4100s yesterday, GBPUSD has come off the boil a little this morning in tandem with a modestly stronger US dollar and currently trades down about 0.2% close to 1.4150. When the pair ventured below the 1.4100 level yesterday, some bears were hoping this might finally herald a break below the 1.4100ish-1.4250ish ranges that the pair had been locked within over recent weeks. Obviously, this was not the case dip buyers/those keen to play recent ranges won out, hence why GBPUSD rebounded from these levels. UK data this morning does not seem to have shifted the dial much for GBP aside from maybe giving it some support, but made for interesting reading.

As expected, data released from the UK’s Office for National Statistics this morning showed the pace of the UK’s economic recovery accelerating in the month of April, given that strict lockdown rules that had been in force since January were drastically eased midway through the month. The MoM rate of GDP growth for the month came in at 2.3%, a little above consensus estimates for a pace of growth of 2.2% and the fastest rate of recovery since last July. Analysts note that UK GDP still remained 3.7% below its pre-Covid-19 level in April – the hope is that this gap can be closed in the subsequent months and, indeed, GDP growth in May is also expected to be strong. However, there are fears that the spread of the delta (India) variant of Covid-19 could complicate things over the summer; infection rates, driven by this variant, have been doubling every week and the UK appears to be at the start of another wave of Covid-19 infections. Given the fact that a majority of the adult UK population now has at least some degree of vaccine acquired immunity to Covid-19, this wave is expected to be far gruesome in terms of hospitalisations and deaths than previous waves, but scientists and members of the government are still fretting about whether or not to press ahead with the next stage of lockdown easing on the 21^st of June (when pretty much all lockdown restrictions would be lifted). If the next stage of lockdown easing is postponed, this could weigh on the economic recovery in the UK. However, most analysts are still bullish on GDP growth for the full year 2021 in the UK; indeed, the Bank of England is forecasting growth of 7.25% this year (the fastest rate of growth since 1941 when the entire British economy was dedicated to the war effort). Other hard data for the UK economy was also released alongside the headline GDP figures; industrial output posted a surprise 1.3% drop on the month which is being put down to oil rig maintenance and the impact of the chip shortage on car production, and construction output saw a surprise 2.0% drop on the month, though this does come after March’s much stronger than anticipated 5.8% MoM rise. Weakness in these two sectors was outweighed by strength in services output, which rose 3.4% MoM, above expectations for a 2.8% rise.

The Day Ahead

It should be a sleepy day in financial markets, with the risk of some pre-weekend position squaring likely the only thing that could really shake things up. The preliminary US University of Michigan Consumer Confidence survey for the month of June will make for interesting reading given that it is a timely insight into the health of the US consumer, but is unlikely to really shake things up.