Inflation Spooks Markets
INFLATION CONCERNS ON THE RISE
It has been a rocky w eek in markets as concerns that a rise in inflation w ill prompt an earlier-than-expected tightening in monetary policy dominated sentiment. The week began with a further increase in commodity prices led by oil prices. Then, a much higher-than-expected rise in US April consumer price inflation seemed to provide concrete evidence that gains in commodity prices and supply shortages are fuelling price rises. Equities fell sharply in response, while bond yields rose. US 10-year Treasury yields hit their highest level since early March (although as yet they have not rebounded above this year’s high of 1.77%), while UK 10-year gilt yields did reach new 2021 highs. There are some signs heading into the weekend that that the mood is starting to calm but some nervousness may persist heading into next w eek. Currency markets have been less thwart. There has been some signs of a US dollar rebound possibly prompted by the risk-off mood.
Central banks have attempted to reassure that the policy environment is not about to change. Policymakers from the US Federal Reserve have been particularly vocal in arguing that inflation pressures are probably transitory as ample slack in the economy as a w hole, and particularly in the labour market, should prevent a sustained rise. Consequently they are still saying that it’s too early to start talking about reducing (tapering) asset purchases let alone to consider tightening policy. Other central banks are largely opting for relatively ‘dovish’ messages possibly in part to avoid a sharp appreciation in their currencies. The coming w eek is scheduled to see a lot more central bank speakers, particularly in the US, while the minutes of the last Fed policy meeting are also released. The policy message is likely continue to be dovish. That is providing only limited reassurance to markets that remain concerned that central bank rhetoric w ill change as the recovery gathers momentum.
UK RESTRICTIONS TO EASE FURTHER
The coming w eek w ill see a further easing of lockdown restrictions in England. PM Johnson continues to suggest that the plan to end all restrictions on 21st June remains on course despite concerns about the new Indian variant of Covid-19. The coming week’s economic data calendar is very busy in the UK but less so elsewhere.
Market focus will particularly be on indications of the strength of the economy’s rebound but also on indicators of inflationary pressures. The most timely UK data w ill be the ‘flash’ Manufacturing and Services PMI readings for May (Fri). Both measures rose sharply last month and services recorded its highest reading since October 2013. As the service sector will have benefited most from the further easing in restrictions, w e expect to see a further rise in the headline index this month to 64.0 from 63.2 in April, while the manufacturing PMI is expected to hold around 60. Both readings would be consistent with signs of buoyant economic activity and an acceleration in Q2 GDP. Of late, the PMIs have also provided evidence of firmer inflationary pressures as supply chain disruptions and higher commodity prices push up input costs. Last month also saw some indications of a firming in labour costs as businesses begin to respond to more positive conditions. Further signs of such pressures in the May results may temper any positive market response to a further rise in output. A further sign of the UK economy’s early response to the easing of economic conditions w ill come from April retail sales. Anecdotal evidence and unofficial surveys point to a rise in sales as non-essential stores w ere allow ed to open. Consequently w e look for a 4.5% rise following March’s 5.0% gain, consistent with a strong pickup in spending as pent-up demand is unleashed. How ever, w e would note that monthly retail sales readings are volatile and prone to surprises. The GfK consumer confidence measure for May w ill provide a further indication on whether sentiment is continuing to improve and w e expect it to rise to -13 from -15, which would be its highest since March of last year. Given renew ed market concerns about inflation, the April CPI reading is also likely to get attention. UK CPI inflation has so far remained w ell below the 2.0% target but a sizeable bounce is expected in April to 1.6%y/y from 0.7% in March, primarily because of higher energy prices. That would still leave inflation below target but it is expected to drift up further in the coming months. The core rate is also expected to rise, to 1.5%y/y from 1.1%. How ever, its detail w ill be watched for any signs of growing pressures. For example, the biggest single contribution to this week’s rise in US inflation was used car prices possibly a result of supply constraints limiting the number of new cars. With similar issues likely to also affect the UK, it will be interesting to see if used car prices here are also on the up. Finally the labour market report for the three months to March is expected to see a further fall in the unemployment rate to 4.8% from 4.9% previously.
EUROZONE & US PMIS TO POINT TO RISING ACTIVITY
Elsewhere the focus is also likely to be on May PMI data. In the Eurozone, the manufacturing measure may slip modestly to 62.5 from a very high reading of 62.9 in April. How ever, the services reading, after moving above 50 for the first time in eight months in April, is expected to rise further to 53.0. In combination, those two readings would historically be consistent with positive GDP. Both May PMI indices for the US are expected to post a further rise in May from already high levels in April pointing to a strong acceleration in Q2 GDP growth.
To discuss how the above may affect your money transfer requirements, please contact your Currency Dealer at Heritage Pay on +44 (0) 207 117 2934.
None of the information in this article is, nor should be construed as, financial advice. All foreign exchange transactions involve risk and you should always seek your own independent financial advice before entering into any foreign exchange transaction.