Ear to the Ground

February 11 2022

Inflation again took centre stage on Thursday as the US released their latest figures. Headline CPI came out at a rather eye-watering 7.5%, the highest reading since February 1982 and above market consensus of 7.2%. Core CPI, which excludes the more volatile food and energy costs, came out at 6%. Key drivers behind the rise in headline inflation were the continued rise in energy costs, labour shortages and supply disruptions.

Whilst these figures are eye catching in their own right other commentators still question how relevant this figure is to the general public. Whilst there may be some prices which have fallen during the period, Crescat Capital point to the price rises we have seen in certain goods and services over the last 12 months. Coffee up 92%, natural gas up 81%, used cars up 45%, US residential housing rents up 13%. Is the 7.5% figure relevant to the working person on the street? Research from Topdown Charts and Refinitiv Datastream shows that almost 90% of countries have produce price inflation in excess of 5% whilst over 50% have consumer price inflation running above the same level.

As a consequence of the higher inflation print some are changing their predictions for rate hikes in the US. Goldman Sachs economists, led by Jan Hatzius, now forecast seven hikes this year, lifting rates by 0.25% at each of their remaining meetings this year. James Bullard, meanwhile, member of the FOMC, went on record saying that he supports raising interest rates by 1% by the start of July. This would need to include a 0.5% hike at one of the meetings.

Bond yields continue to rise on the back of increasing rate expectations. The US 10 year Treasury yield has eclipsed the 2% level whilst the 2 year yield is now at 1.57% as the yield curve continues to flatten. This flattening of the yield curve however should not be seen as being abnormal and in fact has happened in each of the last eight occasions when the Fed has commenced policy normalisation.

As a consequence of bond yields moving higher, we are seeing a sharp fall in the value of global bonds which are negative yielding. This figure is now sub $5 trillion and whilst still a high number it is some way lower than the $18 trillion which we saw at the end of 2020/beginning of 2021. It is not just the fixed income market which higher inflation impacts. In January we saw a strong rotation from growth to value stocks and at an index level the S&P 500 now has the most negative real earnings yield we have seen since the 1950’s.

Finally, although very much a lagging indicator now, UK GDP for Q4 is estimated to have increased by 1% in the 4th quarter of 2021 according to preliminary estimates, with household consumption making the largest contribution. The economy grew 7.5% in 2021, a somewhat different picture to the 9.4% fall that we saw in 2020.

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