- Markets relieved after US inflation report, trading like this is the peak
- Dollar pulls back alongside yields, stocks close at new records
- Massive week lies ahead, featuring five major central bank meetings
Peak inflation?
The latest inflation data out of the United States sparked a relief rally on Friday. Even though annual CPI inflation hit a four-decade high of 6.8%, investors were apparently positioned for an even hotter print after some earlier comments from President Biden that seemed to warn of something worse.
While inflation has surged at a breakneck pace this year, market participants appear to have concluded that this could be the peak as energy prices and shipping costs have started to cool down. With the supply side of the equation improving and the Fed hitting the brakes with some force while fiscal stimulus is withdrawn, inflation anxiety is quietly fading.
As such, traders went on another holiday shopping spree, buying up both equities and bonds in the aftermath. The S&P 500 rose by almost 1% to close at a new record high. Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) were at the tip of the spear as money managers continue to move higher along the quality spectrum, shunning riskier growth stocks now that policy normalization is on the horizon.
Dollar whipsaws, looks to the Fed
In the FX sphere, the dollar got knocked down initially as Treasury yields retreated but it has already recovered those losses. It is crucial to stress that yields fell because some inflation premium was priced out of US bonds, not because the inflation stats changed the narrative around the Fed, which meets this week.
Markets are still pricing in almost three rate increases for next year, so the crucial questions this week are whether the tapering process will be expedited and how many hikes the new dot plot will signal.
Considering just how strong the US economy is, with the labor market tight by several measures and the Atlanta Fed GDPNow model pointing to growth north of 8% this quarter, a hawkish Fed is the most likely endgame. That could keep the wind blowing in the dollar’s direction, especially if the European Central Bank fails to impress with how quickly it dials back its own stimulus.
Central bank extravaganza, gold yawns
Beyond the Fed and ECB, traders will also have to grapple with central bank decisions in the United Kingdom, Switzerland, and Japan this week. The Bank of Japan meeting will probably be another snoozer, but the Bank of England and Swiss National Bank could spark some fireworks.
The spread of the Omicron variant and the recent measures announced in the UK suggest the BoE will almost certainly keep its rate powder dry this time as well. With imminent liftoff bets receding, the pound has been hamstrung in recent weeks, unable to recover properly despite the powerful comeback in risk sentiment.
Meanwhile, the SNB will have to get creative if it wants to turn the tide of the battle in euro/franc, which is currently trading at levels last seen in 2015 after the currency peg was chaotically abandoned. The central bank doesn’t have much left in the armory, so it may resort to threats of stronger FX intervention to prevent euro/franc from heading towards parity.
The narrative that US inflation may have peaked was also reflected in gold prices, which rose only slightly despite the trifecta of a softer dollar, lower yields, and stronger risk appetite. This is in sharp contrast to last month when bullion powered higher amid a genuine inflation scare. 