- US inflation comes in hot, pouring fuel on Fed rate hike expectations
- Dollar hits new highs for the year against euro and sterling
- Stock market feels the heat, gold turns into an inflation hedge
Markets reprice Fed
Another shocking acceleration in US inflation unleashed havoc across global markets yesterday. The annual CPI rate clocked in at 6.2%, overcoming even the most aggressive forecasts. It was the usual suspects such as energy prices and used cars driving inflation higher again, although rents and medical care also fired up, signaling that price pressures are broadening out.
The dollar, Treasury yields, and inflation expectations all charged higher amid bets that the Fed will expedite its normalization plans. Money markets currently point to two rate increases for next year and a 50% chance for a third. An awful 30-year bond auction that saw very poor demand added fuel to these moves.
The question now is whether the Fed will speed up the tapering of its asset purchases in the coming months to address intensifying inflationary pressures and consequently open the door for a rate hike next summer. Any signs that this is under consideration could put more wind into the sails of the mighty dollar.
Euro and sterling battered, stocks retreat
In the broader FX sphere, the euro and British pound took the most damage from the dollar’s resurgence. Euro/dollar and sterling/dollar both fell to new lows for the year in the aftermath, with the pound in particular suffering a double whammy as risk sentiment soured as well.
With Brexit risks back on the radar and the markets pricing in more than four rate increases from the Bank of England next year, there is still plenty of scope for disappointment in sterling.
Stock markets absorbed the initial acceleration in inflation quite well, but the disappointing Treasury auction opened up another can of worms by catapulting yields even higher. That dealt a heavy blow to the yield-sensitive Nasdaq, which lost 1.7% as tech and growth shares came under fire.
That said, the mood has improved today, with a little help from reports that Chinese authorities could take steps to stop the fire sale in the nation’s high yield bond market. Beijing is apparently prepared to relax the rules around how much leverage property developers can take on, allowing distressed companies some breathing room.
Gold shines, oil struggles
The most striking move yesterday was in gold. Whenever there was a similar inflation shock this year, the precious metal got smashed as the dollar and yields went higher on expectations for faster Fed rate increases. That pattern broke yesterday, with bullion storming higher alongside the reserve currency and yields.
One way of reading this is that gold has turned into an inflation hedge again. To be more precise, gold is benefiting from ‘real’ Treasury yields hitting record lows. With inflation firing up, traders are hedging that exposure by piling into inflation-protected bonds, driving real yields lower and putting the shine back into the precious metal.
In the energy arena, oil prices took a sharp hit, virtually erasing all their gains for the week. The drop likely reflects a trifecta of rising inventories, fears that premature Fed tightening could choke the recovery in demand, and speculation that Biden may release the strategic reserves after all following his pledge to fight inflation.
The US bond market will remain closed today in observance of the Veterans Day holiday, although the stock market will be open for business.