Inflation Angst Roils Markets

On Wednesday, the Dow fell 1.99% to register its largest single-day loss since January, wiping out all of its month-to-date gains, while the S&P 500 and the Nasdaq dropped by more than two percent respectively.

The MSCI Asia Pacific index followed suit on Thursday morning by erasing all of its year-to-date gains.

Markets spooked by higher-than-expected CPI

Wednesday’s US inflation data release shoulders much of the blame for extending this week’s selloff. The headline consumer price index increased by 0.8% compared to the month prior, which was its highest print since 2009. Meanwhile, the core CPI, which strips out food and energy, saw its highest reading since 1982 with a 0.9% rise month-on-month.

Global investors have been caught in the whirlwind of US economic data – from last Friday’s utterly disappointing nonfarm payrolls, to Wednesday’s higher-than-expected inflation prints – which have resulted in a volatility spike. Yesterday, the VIX index soared past its 200-day moving average to reach its highest levels since March.

Inflation reaction differs between markets and Fed … for now

The latest inflation prints are stoking market fears that runaway prices may crimp the ongoing economic recovery, while potentially forcing the Fed’s hand to intervene by reining back its support measures.

US stocks and Treasuries have tumbled under the weight of uncertainty over the inflation outlook and its implications on the Fed’s policy timelines. 10-year Treasury yields made another run for the psychologically-important 1.70% mark, which in turn lifted the US dollar along the way, while the breakeven rates on the same tenor have reached a new 8-year high.

Shortly after the April CPI figures were released, Federal Reserve Vice Chairman Richard Clarida sought to repeat the central bank’s view that such readings on inflation are set to be “transitory” and that policymakers remain some ways from paring down its asset purchases. It’s a message that markets clearly have a tough time swallowing, as they continue to question policymakers’ will to sit on their hands and ride this out.

More volatility ahead?

These concerns could be further stoked by the incoming US economic data releases, including today’s weekly jobless claims and PPI figures, as well as Friday’s announcements on retail sales, industrial production, consumer sentiment and inflation expectations.

Still, considering the extent of the reaction thus far, market moves may be relatively muted over the coming days. At the time of writing, the futures contracts for the Dow, S&P 500 and Nasdaq 100 are all in the green, as US equities try to nurse their wounds after the recent bruising selloff.

What is clearer is that the US inflation outlook remains the major theme in play for global markets, with investors ever willing to adjust their expectations, and subsequently their asset allocations, according to the shifting nuances in this ongoing debate.

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