US inflation on Wednesday, big stake for financial markets

Inflation is mainly at the origin of the significant movements observed on the various financial markets, both the foreign exchange market, the equity markets and obviously the bond markets.

This continued rise in prices prompted the Fed to toughen up its rhetoric at the end of the fourth quarter, raising the range of its main rate by 0.50% in one fell swoop. Knowing that other increases of the same magnitude are not ruled out by the central bank at future meetings.

The consequences of this surge in prices and the normalization of the Fed’s monetary policy are a rapid recovery in US rates, both short rates and long rates, logically leading to a recovery in real rates, i.e. say inflation-indexed rates. A few figures to better appreciate the speed of the movement: in mid-November, the US 10-year real rate was still moving very largely into negative territory, at -1.25%. Six months later, at the start of the week, it was at +0.35%, i.e. its highest level since mid-2019.

This change from very negative to positive territory in the space of only 2 quarters resulted in a sharp erosion of the TINA effect (“There Is No Alternative”) which was very visible on the stock market indices and in particular the indices heavily weighted in growth stocks (techs) such as the Nasdaq100 for example. Even before the war in Ukraine began, the Nasdaq100 had already lost nearly 20% in just two months.

Even the indices more sensitive to cyclical values, such as the European indices for example, had also lost ground on this erosion of the TINA effect, before the geopolitical crisis erupted at the end of February.

The war in Ukraine and then the confinements in China added additional pressure to a price dynamic already launched at full speed.

The sharp rise in the dollar, the fall in technology stocks (nearly half of Nasdaq Composite stocks are down 50% from their peak), the collapse in sovereign bonds (and high yield bonds) but also the fall major cryptocurrencies: a relatively large part of the downward adjustment of many assets is linked to inflation and the monetary normalization it generates as a result, the other part being linked to the direct economic consequences for companies of the geopolitical situation and global logistical tensions.

This is why the inflation figures in the United States, which will be published on Wednesday, will be a major indicator for the markets. And take on a particular character because, unlike in previous months, the consensus is this time banking on a less strong rise in prices. The consensus for April CPI inflation is at 8.1% y/y versus 8.5% for the March figure.

If this is indeed the case, the general state of mind of the markets could start to evolve, considering that the peak inflation will have potentially been reached. A peak in US inflation does not necessarily mean a rapid relapse in prices, but the markets could begin to change their one-way vision and consider a more “consolidating” stage. And this could begin to be felt with the beginning of a change in appetite for the dollar, thus benefiting the euro, a slight easing in short rates and perhaps the beginnings of a stabilization in the equity markets.

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