Markets took inflation in their stride – weekly update 19 February

Equities shrugged off inflation data

The main event last week was the dog that didn’t bark around inflation. Following the strong wage data in January’s jobs report, there was a lot of attention on the CPI print from the US. This came above expectations as prices rose 2.1% year on year (yoy) in January, unchanged from the December reading and ahead of forecasts for a deceleration to 1.9%. The core CPI measure, which strips out the volatile elements of food and energy, was also unchanged at 1.8% yoy against forecasts for 1.7%.

Inflation was broad-based with clothing especially strong. What was surprising was the reaction in equity markets. They appeared to shrug off the news and rise modestly on the day – perhaps an indication that last week’s shake-out has gotten markets back into a more rational, less fickle mindset.

By contrast, core bond markets initially sold off with 10-year US Treasury yields hitting 2.94%. It was a similar story in the UK with CPI unchanged at 3% (2.9% expected) and a slowdown in fuel offset by a relative increase in recreational spending, especially on attractions such as zoos and gardens. Core CPI rose by 0.2% to 2.7% (2.6% was expected). It is also noteworthy that growth in Owner Occupiers’ Housing costs slowed, although this is not a major component of CPI or Core CPI.

Disappointing economic data elsewhere

Other economic data was disappointing. In the US, January saw retail sales fall -0.3% month on month (mom), well below expectations for 0.2% growth. The reading for December was revised down from 0.4% to 0.0% with the slowdown reportedly spread across most segments of the retail market.

UK results were also disappointing. Despite retail sales growth accelerating from a revised 1.5% to 1.6% yoy, this was a long way below the 2.5% forecast and pointed to fairly depressed consumers, possibly put off by price inflation.

US Industrial Production was also soft, falling -0.1% mom from 0.4% in December and against an expected 0.2%.

Last week’s other events

• Japanese fourth-quarter GDP grew at an annualised 0.5%, a slowdown from 2.5% in the previous quarter and short of the 1% forecast
• Eurozone industrial production surprised on the upside, growing at a potent 5.2% yoy from 3.2% previously and well ahead of the 4.2% expected
• US consumer sentiment as measured by the University of Michigan rose from 95.7 to 99.9 (95.5 was expected) with both current conditions and expectation gauges improving

The markets

Equities staged a decent rally, despite inflation numbers being stronger than expected, whilst bonds remained fairly restrained and commodities bounced.

Equities

There was a broad rebound across the major developed markets last week, led by US equities, with the S&P 500 rising 4.4% on the week. Europe trailed just behind with the MSCI Europe ex-UK Index up 3.3% and the MSCI United Kingdom Index up 3.1%. The Japanese TOPIX index was the notable laggard, down by -1.7% midweek before recovering and achieving a modest 0.3% growth for the week. Emerging markets (MSCI measure) returned 4% for the week.

Bonds

Core sovereign bond yields generally rose on the week, but rallied back down on Friday. By the end of the week, 10-year US Treasury yields were 2 basis points (bps) higher to 2.87%, UK 10-year gilt yields were just 1 bp higher to 1.58% and the equivalent German bund yields were overall lower on the week following Friday’s move, ending 4 bps lower at 0.71%.

Commodities

The broad commodity complex rallied during the week. Brent Crude Oil ended the week up to US$64.8 per barrel, Gold rose to US$1,346.96 per ounce and Copper was last seen at US$3.05 per lb.

Currencies

The US dollar weakened through the course of the week and the Japanese yen was broadly stronger. Sterling ended on Friday at US$1.40, €1.13 and ¥149.

The week ahead

It’s a fairly quiet week ahead with the PMI releases as the main highlight. Starting with Eurozone PMI on Wednesday morning, there are expectations that Manufacturing PMI will cool slightly from 59.6 to a still impressive 59.3, whilst Services PMI is expected to dip from 58.8 to 58.4. It’s the turn of US PMIs from Markit on Wednesday afternoon with Manufacturing PMI expected to be unchanged at 55.5 and Services PMI expected to have risen 0.7 points to 54. Wednesday also has some interest for the UK with the latest jobs data (details below). With inflation at the forefront of people’s minds, there could be some interest in Japanese inflation on Thursday evening with CPI expected to increase from 1% to 1.3% yoy. The daily breakdown is as follows:

Monday: a quiet day with the UK latest house prices and Eurozone Construction Output in the morning as the only releases of note. President’s Day in the US means there are no releases from across the pond.

Tuesday: the ZEW survey of Eurozone business sentiment is the only notable release on the day.

Wednesday: Japanese Manufacturing PMI is released early in the morning. The UK will update jobs numbers later in the morning, including unemployment (no change at 4.3% expected) and average weekly earnings (expected to be unchanged at 2.5% yoy). In the evening, the Federal Open Market Committee minutes from the January meeting are released, though these could be considered somewhat obsolete given the data and sentiment shifts that have subsequently taken place.

Thursday: the UK updates its preliminary estimates for fourth-quarter GDP growth in the morning, which will give more details on the main drivers of growth. In the afternoon, US Consumer Comfort and Leading Index readings are released in the US before Japanese CPI is reported just before midnight, UK time (a 0.3% increase to 1.3% yoy is expected).

Friday: It’s a quiet end to the week with only the final reading of Eurozone CPI of any real note.