17 May 2021
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US inflation surprises to the upside

The bigger-than-expected US inflation print for April led to pronounced market volatility last week, prompting more statements from Federal Reserve officials that this would only be transitory

By Daniel Richards

  • The bigger-than-expected US inflation print for April led to pronounced market volatility last week, prompting more statements from Federal Reserve officials that this would be only a temporary phenomenon – albeit one that would likely last for several months, with last month’s rapid acceleration unlikely to be the last. CPI inflation came in at 4.2%, the fastest pace since 2008 and markedly higher than the consensus projections of 3.6%. Fed vice chair Richard Clarida acknowledged surprise at the news over the weekend but maintained the party line that it would be transitory, boosted by base effects and some pent-up demand as the economy reopened.
  • The Fed’s view is that the economy remains some distance from the level of recovery that it wants to see before it even vocally contemplates rolling back QE or especially hiking interest rates. The disappointing NFP report the previous week provided ammunition to this view, and there were some other data points at the end of last week which further confirmed that the recovery will be a bumpy ride. Retail sales in April were flat on the previous month, missing consensus projections of 1.0% growth, and it will be interesting to see how this indicator performs next month when the direct payment stimulus cheques are no longer in the m/m base. Industrial production also missed estimates with 0.7% m/m growth in April, down from 2.4% the previous month, while the University of Michigan sentiment index came in at just 82.8 in its preliminary May reading, missing projections of 90.0. In terms of the labour market, initial jobless claims was one indicator that did beat projections in data last week, coming in at 473,000 in the week ending May 8, compared to estimates of 490,000 – but the previous week’s numbers were revised up by 9,000 to 507,000 and this remains some way above the pre-pandemic norm of around 200,000 new jobless claims each week.
  • Chinese industrial production expanded 9.8% y/y in April, just shy of consensus projections of 10.0%. Retail sales disappointed however, recording growth of 17.7% compared to estimates of 25.0%. The base effects play a part – having been the epicentre of the disease, and enacted a decisive lockdown, by April the worst was behind it – but this is not the only dynamic, and the data suggests that domestic demand remains relatively weak. Chinese products related to the pandemic crisis – ie medicine – remain a key driver of production, while metals and machinery are also important at present.

Today’s Economic Data and Events

16:30 US Empire manufacturing survey, May. Forecast: 24

Fixed Income

  • The US Treasuries market endured the first of what will be several elevated inflation prints last week with the April headline CPI coming in at 4.2% y/y, its highest level since 2008. Treasuries collapsed on the data with yields on 10yr USTs soaring above 1.7% mid-week before settling at 1.6284%, a gain of more than 5bps on the week. The movement in the 10yr UST was echoed across the curve with 2yr UST yields popping to more than 0.17% after the April inflation before falling to 0.147% at the close, roughly flat on the week.
  • Fed officials have continued to push their line that inflationary pressures in the economy are transitory and that supply-chain bottlenecks will adjust and allow for prices in sectors like car sales and building materials to ease later this year. Beyond the inflation print, other data from the US showed a more mixed picture: retail sales were flat m/m in April and industrial production is lagging, reflecting the tightness in some supply chains.
  • Elsewhere in fixed income markets, high-yield and emerging market USD bonds sank last week. Local currency EM bonds also showed some weakness. Yields on 10yr Turkish government bonds added 17bps during a holiday-shortened week and traded at 17.44%. South African 10yrs added almost 7bps to yield 9.093% while Indian 10yr government bonds managed to rally and push yields back below 6% again.
  • Local primary markets have been quiet thanks to Eid holidays across much of the region.
  • Central bank action is limited this week with Sri Lanka and South Africa taking policy decisions on May 20 (both expected to leave policy unchanged). Minutes of the Fed’s April meeting—and debate on the inflation outlook—will be in focus for the market.

FX

  • The jump in UST yields mid-week helped to propel the dollar higher, although most of the gains came in the immediate aftermath of the April inflation print. The DXY index closed at 90.321 on the week, up 0.1% but did sink nearly 0.5% on Friday alone as retail sales and industrial production data came out more downbeat.
  • The Euro fell 0.2% over the week to settle at 1.2141 although it showed a mirror image to the dollar’s performance. Most of the losses came about mid-week while EURUSD gained over the final two trading sessions, adding 0.5% on Friday. USDJPY showed similar action, jumping almost 1% on May 12th before edging lower to record a weekly rise of almost 0.7%, settling at 109.35.
  • Sterling also benefitted from the weaker dollar, moving back up above the 1.40 level and adding 0.8% on the week. Gilt yields recorded a larger gain than Treasuries, up 8bps on UK 10yrs, helping to support the outlook for sterling assets generally amid an improving economic picture.
  • In the commodity currency space, the loonie was the outperformer with USDCAD declining 0.24% on the week while both the AUD and NZD recorded losses against the greenback.
  • Among emerging market currencies, USDTRY pushed up to 8.451, a rise of 2.6% while USDZAR saw a more muted depreciation for the rand with a rise of 0.5% last week. USDINR managed to hold ground though, falling by 0.3% to 73.294.

Equities

  • Equity markets were dealt a body blow by the upside surprise in the US inflation print last week, as expectations that rapid price growth would entail more rapid tightening of policy by the Fed reduced the perceived present value of many stocks – especially those in the technology sector. On Thursday the S&P 500 lost -2.2%, while the tech-heavy NASDAQ lost -2.7%. Some of these losses were recouped on the last day of the week, as the S&P 500 closed up 1.5% on Friday and the NASDAQ 2.3%, leaving them down -1.5% and -2.3% w/w respectively. The blue-chip Dow Jones was the week’s winner, though that too closed the week down -1.1%.
  • It was a similar story in Europe, with most major equity indices ending the week lower, despite gains on Friday. The FTSE 100 lost -1.2% w/w, while the composite European STOXX 600 lost -0.5%. The CAC closed flat on the week after a 1.5% gain on Friday offset earlier losses, while the DAX gained 0.1% w/w.
  • In Asia the Shanghai Composite was a notable gainer last week, adding 2.1%, but this was an outlier as most major indices closed lower. Japan’s Nikkei lost -4.3%, reflecting the ongoing struggle with a new surge in coronavirus cases there.

Commodities

  • Oil prices moved in a wide range as the market absorbed disruptions to a major refined product pipeline in the US. Both Brent and WTI futures managed to record a third consecutive weekly gain, rising 0.6% in the Brent market to USD 68.71/b and more than 0.7% in WTI to USD 65.73/b. However, Brent did get close to USD 70/b mid-week while WTI did push to almost USD 67/b at its intraweek high.
  • Market structures still point to relative tightness in the coming months. Brent 1-6 month time spreads closed in a backwardation of more than USD 2/b last week, up slightly week on week, while the same spread for WTI closed just shy of USD 1.50/b.

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Written By

Daniel Richards Senior Economist


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