Inflation, central bank hawks, and China

The Eurozone’s flash CPI estimate looked as ugly as it smelled beforehand. Inflation in the Eurozone is estimated to have barely eased to 8.5% from 8.6% printed a month earlier, while core inflation advanced to a record of 5.6%, from 5.3% printed previously.

Inflation has not been transitory, but disinflation could be.

The latest CPI update confirmed the European Central Bank (ECB) hawks’ aggressive positioning for further rate hikes. The ECB head Christine Lagarde told the Spanish TV that the rate hikes will continue beyond the next 50bp hike. The ECB meeting minutes showed that policymakers are betting for a soft landing at this point, and they are not worried about a too aggressive policy tightening.

All that pushed the European yields further up yesterday.

The kneejerk reaction from the equity markets was a selloff. The Stoxx 600 dived to a month low, but then rebounded as a big part of the disappointment was already broadly priced in and out, so tactical investors took profit on a bearish trade and walked away.

As a result, and despite higher yields across the board, the Stoxx 600 closed Thursday’s session 0.50% higher.

Stickiness doesn’t only concern inflation, but also the bullishness of equity investors.

The euro, on the other hand, gave a timid reaction to the CPI data and spent most of the day giving back field against the dollar. The EURUSD is around 1.06 at the time of writing.

From a technical standpoint, the bullish trend remains intact but looks vulnerable due to potentially stronger Federal Reserve (Fed) hawks. The key support is seen between 1.0470/1.05, including the 200-DMA, and the major 38.2% Fibonacci retracement on September to February rally.

The only silver lining in the inflation data is that, February is the last month where we compare the war times to no-war months. Therefore, the base effect should ease the positive pressure on fresh figures starting from March. But this is just an expectation. It is not a certainty. Until we have the certainty, the yields are up, and outlook for equities is… well, AT RISK.

The gowing gap between the stock and bond markets is alarming. The most likely scenario is a significant correction in stock valuations. A stock rally is unsustainable if yields are headed higher.

Latest jobs figures heats inflation worries

Fresh jobs data came to fan the inflation worries yesterday in the US. Weekly jobless claims came in lower than expected, unit labour costs surged 3.2% in Q4, much slower than the 8.2% printed at the Q1 of last year, but twice as fast as predicted by analysts. For the full year of 2022, unit labour costs surged 6.6%, compared to only 2.6% printed for 2021.

Fresh data is just another piece of a puzzle where we start getting a bad sense of what’s next.

But again, 2021 was a peaceful year, while 2022 was a war set up. We will start seeing an important easing just due to the base effect in the coming months. Is this what keeps equity investors swimming against the tide? Hope that the latest uptick in inflation is transitory?!

The US, the 2-year yield came a notch closer to the 5% mark, the 10-year yield advanced further above the 4% level, while the 30-year yield hit 4% for the first time since November.

There is no doubt in the bond markets about the direction. It’s down.

What’s bizarre is the reaction in equity markets. Yes, the S&P500 kicked off the day in the negative, even tipped a toe below the so-closely-watched 200-DMA. But the index rebounded on the back of dovish comments from Raphael Bostic, who said that the Fed should pause the rate hikes sometime this summer.

Well, if the equity rally is holding on to a few dovish-sounding comments, defying fresh data that goes clearly in the direction of further rate hikes, then the correction could in fact be ugly.

Ugly, yes, because, the widening gap between stock and bond markets becomes more alarming by the day. And the equity rally is not on solid ground.

Looking at the S&P500, the index closed yesterday a touch below the 50-DMA, further selloff below the 200-DMA was avoided thanks to Raphael Bostic…(?) But the outlook isn’t any brighter. On the contrary, the chance of a selloff intensifies by the day.

FX & energy

The US dollar trades in line with the hawkish Fed expectations, and the USDJPY has now stepped into the bullish consolation zone, having cleared the major 38.2% Fibonacci retracement on October to January retreat, to the upside.

In energy, oil bulls are working hard to drill above the 50-DMA resistance, and further good news from China is supportive. After encouraging manufacturing PMI data earlier this week, the Caixin services PMI printed the fastest growth since last August.

China is not China we knew

Yet, the strong data from China is shadowed by Xi Jinping’s new crackdown on bankers, China’s close relationship with Russia and the deteriorating ties with the US, and China’s changing landscape due to Xi’s economic and political policies.

Nothing in China will be as bright as before 2020.

Therefore, the China factor could not be enough to convince the oil bulls to break the back of the 100-DMA resistance.

And pray for the 100-DMA to remain tight, because if energy prices gain momentum, the inflation discussion will get uglier.