Bassanese Bites: Inflation Watch – February 15 2021

Global markets

Global equities continued to grind higher last week in the absence of bad news. Biden’s massive U.S. fiscal stimulus package remains the ‘gift that keeps on giving’ as it slowly winds it way through Congress and gives equity bulls something positive to talk about on quiet days. The U.S. Q4 earnings season is also winding down, with results again pleasantly surprising to the upside. Contrary to some fears, the January U.S. CPI inflation report also remained fairly benign.

Indeed, probably the main market concern these days, apart from any COVID relapse, is that the synchronised global demand rebound seemingly underway – coupled with lingering supply bottlenecks – could lead to an upsurge in consumer price inflation over at least the short-term. Pricing pressure is certainly evident in many commodity markets, with oil prices pushing higher – and the recent move higher in bond yields is also worth watching. Indeed, both U.S. and Australian 10-year government bonds yields have lifted around 25-30bps so far this year to almost 1.25%. For what it’s worth, this is where my modelling suggests yields should be given current low cash rates and market expectations for no move in official rates in either country over the next 12 months – suggesting further upside should be limited.

That said, while central banks are unlikely to change their tune any time soon, yields nonetheless appear vulnerable to an inflation surprise and an associated knee-jerk market response. Of course, whether inflation (in particular U.S. inflation) picks up remains to be seen – while I don’t rule out a short-run spike higher, I’d see this as an overdue buying opportunity rather than a cause for longer-run concern. Of note, moreover, apparent inflation concerns are not being validated by gold prices – which continue to weaken in the face of rising bonds yields and despite a still subdued U.S. dollar.

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