- Rising yields and inflationary pressures hurt sentiment again
- Inflation expectations continuing to rise
- Pressure on grows on EM currencies
- Crude oil and energy stocks could be dragged lower next
- RBNZ hikes but NZD drops anyway
- ADP payrolls coming up
Another day, another rise in yields… and another drop for equities, emerging market currencies and many other risk-sensitive assets. That has been the underlying trend for the past month or so, and it was no different this morning as European indices and US futures slumped, while the US dollar rose against commodity dollars and emerging market currencies. Here’s how the Spanish Ibex looked like after this morning’s slump:
The latest falls for equity indices come after the markets had rebounded noticeably on Tuesday, although as those gains have now evaporated, it more or less confirms Tuesday’s moves were driven in large parts by short-side profit-taking.
In FX, The EUR/USD closed in on the 1.15 handle, while the Norwegian krone slumped as oil turned lower.
Why are the markets struggling?
Well, there are many reasons. But it
all boils down to rising yields and inflationary pressures. Bond yields have broken further higher both in Europe and the US as investors fear that the Federal Reserve and other global central banks might be forced to tighten their belts faster than expected to prevent high inflation turn into hyperinflation, and to avoid the risks of stagflation taking hold.
Energy prices have sky-rocketed, fuelling fears that inflation is not going to be transitory as many central banks – not least the Fed and BoE – have been expecting. Indeed,
gas prices in the UK have surged by
40% to fresh record highs. The energy crisis has worsened in Europe, with
Dutch gas futures surging over 60% in just two days this week. Rising energy prices is not only impacting households but businesses too, adding to their costs. The net result would be higher prices for the goods and services, potentially meaning lower demand from households, already hit by rising energy prices eating into their own disposable incomes.
Inflation expectations continuing to rise
With energy prices surging, inflation expectations are rising accordingly. One key measure of long-term Eurozone inflation expectations has today risen to its highest level since 2014. Similar scenes are witnessed for market-based measures of inflation for other western regions, including the UK and US.
RBNZ hikes but NZD drops anyway
All this come at a time when the global economy appears to be slowing and central banks are starting to tighten their belts. The Reserve Bank of New Zealand becomes the third major central bank to hike interest rates overnight by 25 basis points. This was the first hike in seven years as concerns over rising property prices and inflation outweighed the risks stemming from the spread of coronavirus. Still, the NZ dollar fell, as the rate increase was fully expected and as appetite towards risk-sensitive assets turned sour.
Pressure on grows on EM currencies
It remains to be seen how the Fed will react if inflation remains persistently high amid the global energy crisis and supply bottlenecks. Until now, the message has been a gradual withdrawal of support. But the markets are thinking otherwise, as yields continue to rise on both short and longer ends of the curve. The dollar is making big gains against some emerging market currencies, with the Indian Rupee dropping sharply again today. India is a major oil importer, so there’s little surprise to see her currency struggle. Keep an eye on Mexican peso, as it has just broken out above 20.70 resistance.
Crude oil and energy stocks could be dragged lower next…
While growth stocks, especially those in the technology sectors that have low dividend yields, have taken the brunt of the sell-off, we are seeing other sectors come under increasing pressure too. Miners have fallen on concerns over a slowing Chinese economy and tracking falls for Iron ore and a few other base metal prices. Energy companies such as BP and Shell have so far bucked the trend, thanks largely to significantly higher crude oil and gas prices. However, if risk appetite turns decisively sour, we could see energy prices fall back as fears over demand intensify. In fact, crude oil prices fell along with equities today and this pressured share prices of BP and Shell and the like. Banks have so far also bucked the trend, thanks to those rising bond yields. But they won’t be totally immune should you-know-what hit the fan. Still, HSBC got a boost today following a broker upgrade. Elsewhere, Tesco shares jumped after the superstore giant topped first half forecasts, raised guidance and announced a £500 million share buyback scheme.
Coming up…
If stagflation concerns linger, we might see renewed falls for US indices when Wall Street opens later. Already, index futures were down sharply, and trading the day’s lows when this report was written. Investors will be looking forward to the release of ADP private sectors payrolls report and a few other economic pointers later this week, including the official nonfarm payrolls report on Friday. The ADP is expected to reveal 425K jobs were added into the US private sector last month. Jobs growth has slowed down in recent months. If we see further signs of weakening jobs market for the world’s largest economy, then expect to see more jittery price action across risk assets.
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