Last week continued in the same vein as the previous one for bondholders, as January’s highly anticipated US CPI print surprised to the upside with the headline reading at 2.1% yoy and the core at 1.8%yoy. The weak retail sales readings were largely ignored by asset markets, so the knee-jerk sell-off across the Treasury curve followed the stronger inflation print. Also ignored was a pick up in PPI data, but a weak Empire Manufacturing release brought some respite to the UST curve; the yield on the 10-year eventually closed the week marginally higher at 2.88%. Meanwhile, despite a rally on Friday, the dollar remained on the back-foot over the week. Elsewhere, the offshore renminbi (CNH) continued to strengthen against the greenback closing below 6.30 and the Japanese yen rallied a further 2.44% against the dollar last week; helped by comments from Japan’s finance minister that no market intervention - to slow pace of appreciation - is required at this stage. Brent also enjoyed a bounce last week. The UAE Minister of Energy and Industry’s statement that the group of Emirates is “determined to pursue” Saudi’s efforts to stabilise oil markets over the weekend will no doubt support Brent at these levels.
Going back to the inflation ‘hysteria’, we had expected a bounce at the beginning of the year, and still remain of the view that it is a short-term theme as there are several indicators (such as vehicle sales and mortgage delinquencies, for example), which paint a much more pessimistic view of the economy. However, the market has clearly reacted more than we had expected over the last several weeks, with the UST sell-off exacerbated by the high levels of funding. Just on that, this week will see USD 258bn worth of UST auctions; across short-term bills to 7-year maturities, so the shorter-end of the curve could come under pressure.
We do think the Fed will continue to tighten especially if we see inflation pick up further, and that along with their balance sheet management will combine to move us closer to the end of this cycle which is now in its 104th month of expansion. For the cycle to really start to turn we would need to see a prolonged or very sudden decline in equity markets, and until and unless that happens consumer confidence will likely remain relatively high. So, a difficult month for us so far on our long-only portfolios but we still believe that this is an inflationary blip, not a constant move higher in prices. We continue to monitor the situation daily.
Expect a relatively quiet day today as both US equity and bond markets are shut for President's Day, and China is out celebrating Lunar new year. Closer to home, EU finance ministers will decide on the next ECB VP and the Greece bailout will also be discussed. UK house price data could be of interest, as could Japan’s trade releases. Another quiet day on the data front will see Germany’s SPD begin a two-week session for members to vote on the coalition pact proposal, on Tuesday. Wednesday could breathe some life into markets as we receive what are expected to be more hawkish tones from the FOMC ‘s January minutes and the BOE’s inflation report. A number of EU flash PMIs could be of interest, along with UK jobs data. Thursday will kick-off with the Chinese markets opening the year of the dog, and later the preliminary Q4’17 UK GDP readings could garner some attention. Friday will see another quiet day in terms of data and activity, with the only key features being NY Fed Dudley’s discussion on the Fed’s balance sheet and the central bank’s semi-annual monetary policy report to Congress, and Japan’s CPI print. Watch out for a number of Fed speakers this week, we expect more hawkish rhetoric, but still a gradual approach to rate hikes.