Risk Off!

Week Ending, 12th April, 2024

There has certainly been an air of “Risk Off” this week spiked by a couple of factors:

US Inflation data: Wednesday saw the release of March’s Consumer Price Index inflation. It was not great! It came in with a rise of +0.4% on the month to 3.5% y/y (year-on-Year). Even stripping out the volatile Food and Energy components, it still registered +0.4% m/m to stand at 3.8% y/y. A rise of +0.3% on the month had been forecast. Energy (+1.1% m/m) and shelter (+0.4% m/m) were the main drivers. Food rose +0.1% m/m with big rises in meat, fish, poultry and eggs (+0.9% m/m). Bonds sold off as markets freaked out at prospects the Fed will delay rate cuts even further! A $39bn Treasury bond auction of the Notes maturing in 10-years shot up +21 bps (i.e. +0.21%) as dealers demanded more interest to compensate them for having to take on extra holdings of it seeing as coverage was poor (just over 2X i.e. demand vs the supply ratio). In the secondary market, the benchmark 10-year Treasury shot up +19 bps (+0.19%) to yield 4.55% marking its highest level since mid-November 2023. The gap between the Fed Funds Rate (FFR) and the US 10-year yield (some 80 bps or 0.80%) is, many argue, the extent to which the bond market is in denial – and that’s despite a rise of some +0.80% since late last year! This is where the inflation view counts. Today’s 10-year yield equates with inflation sub-3%. Something is out of kilter. The carnage was not limited to the 10-year Treasury. The 6-month yield jumped +0.06%, the 1-year +0.16%, 2-year +0.23%, 3-year +0.25%, 5-year +0.24% and 7-year +0.21%. The average 30-year Mortgage shot up +0.285 to 7.34% - its highest since 20th November last year. This will hurt any home buyer who needs to buy. As a comparative, in 2022, it was 6%. Supercore inflation (=core inflation with the housing component removed) is rising at 7.5% y/y (that’s just from Feb to March). Ouch!

Then, on Thursday, we had the Producer (or Input) price inflation (PPI) – this focuses on input prices paid by companies for services and goods. On the surface – because it was in line with expectations without rising sharply as it did a month back – it was seen as a “panic over” moment. This type of inflation is notoriously volatile on a monthly basis and also has seasonal adjustments made to it to take account of the time of year. March’s adjustments were big! The unadjusted PPI spiked to 6.2% y/y while the seasonally adjusted spiked even higher to 7.8% y/y…..and with energy prices continuing their ascent, it’s a concern to the Fed and others. The March FOMC minutes did allude to rate cuts happening in the near future…..for this tightening cycle. Nearly all of them judged it would be appropriate to move policy to a less restrictive stance at some point this year if the economy evolved broadly as they expect. However, the same participants also noted indicators pointing to strong economic momentum and disappointing readings on inflation in recent months and commented they did not expect it would be appropriate to reduce the target range for the federal funds rate until they had gained greater confidence that inflation was moving sustainably toward 2 percent.

Energy prices: Speaking of inflation, the oil price has seen big gains this year, some +20% or more. While US production dropped sharply in January on the back of temporary factors (extreme January weather, transportation constraints in the Permian region for Natural gas, a drop in the rig count and seasonality), the main risk remains geopolitical (possible retaliation by Iran on Israel and continuing war between Russia & Ukraine). As a result, OPEC will continue to hold the balance on the production front as the US’ response will be limited while it takes time to recover production back to original levels. January production alone fell -700,000 barrels pd and is still some -200,000 bd below March’s forecast. So, for now, it looks like higher oil prices will stick around – and that gives time for prices to settle into the inflation spectrum.

Given the current picture, Commodities will remain well-buoyed as an asset class. As long as sentiment stays cautious – even nervous – the likes of gold will hold up. Given how rate cut sentiment has diminished, it will take something significant to topple gold at this point in time. The fear gauge (the VIX – Volatility INdex) is up sharply just today alone (+28.37%) to 19.13 while markets see red.

MARKET UPDATE