Inflation and rising yields to guide investors

Stock investors across the globe are eagerly awaiting the next US inflation report due on Wednesday. Rising bond yields and earlier anticipation of stimulus withdrawal dragged US equities lower last week with the S&P 500 posting its worst start to a year since 2016. Tech stocks were dumped as US 10-year yields climbed 29 basis points in five trading days to reach 1.8% on Friday. Meanwhile, cyclical stocks were the primary beneficiary from rising rates, with the financial sector up more than 5%.

Investors have got used to low bond yields for years, so it's natural to see risk assets, especially those overvalued ones, being hit when rates suddenly climb higher. If US 10-year yields surge by a similar magnitude over the next few days, expect the selloff to worsen as most investors rush for the exit door.

Friday's US Nonfarm Payrollsl headline number was disappointing. The 199,000 jobs added in December were significantly short of the market's estimate of 450,000, but that won't change the interest rate outlook. The unemployment rate dropped to 3.9%, fast approaching the five-decade low of 3.5%. The decline in unemployment came despite the labor force participation rate holding steady at 61.9%. But it's wages that should be of great concern. Average hourly earnings climbed 0.6% in December and were up 4.7% compared to a year ago. It's good to be paid more when prices increase, but higher wages also suggest that further inflationary pressures need to be controlled sooner rather than later.

The Omicron variant is probably less severe than previous ones, but it could still disrupt supply chains and this has been a significant factor in rising inflation. While these disruptions will eventually ease, prices will take longer to adjust, mainly due to economic behavior. The longer prices remain elevated, the stickier they become.

Markets are anticipating another 40-year high for US CPI when the figure is released on Wednesday. Consumer prices are expected to have increased 0.4% in December compared to the previous month and 7.1% year-on-year. Another surprise to the upside will possibly put more pressure on bonds, sending yields higher.

Speeches from several Fed speakers this week will also be scrutinized closely for further clues on policy tightening, with Fed Chair Jerome Powell's hearing tomorrow under the spotlight.

A correction of 10% or more in stocks from the peak may occur anytime soon but given there's still a lot of cash on the sidelines and earnings are likely to remain robust, these factors will continue to lead equities higher in the medium term. However, investors need to be prepared for higher volatility ahead.