Inflation isn’t failing to surprise!
The hot US consumer prices reading released on Wednesday reignited the debate about whether inflation is transitory or here to stay for longer.
Inflation is now running at its highest levels in more than three decades with CPI surging 6.2% year-on-year in October. The figure was well above expectations of 5.8% and continues to challenge the Fed’s “transitory” narrative.
It’s not just the headline number that is of great concern, but even when you exclude volatile items such as food, energy, used cars & trucks, inflation is running at its highest levels in 30 years.
Given that demand for many of the categories in the report is inelastic such as food and energy, consumers will be left with less disposable income, and that’s a big challenge ahead. From yesterday’s market reaction, investors are no longer believing the transitory story. The question has become how long it will last and how bad will it be.
The US 2-year Treasury yields surged 23.6% on the data and now hovering near March 2020 levels above 0.50%. The 10-year note surged by the most since February to settle at 1.57%. The sharp increase in yields reflects bond investors’ expectations of an earlier tightening in monetary policy with at least two interest rates hikes in 2022.
In currency markets, the greenback has been the primary beneficiary with the dollar index touching the key 95 level for the first time since July 2020. A break above this level could lead to further strength in the dollar, especially against currencies in which central banks seem lagging on policy tightening like the Euro and Japanese Yen. However, a steady rise in the dollar requires confession from Fed officials that inflation is stickier than previously thought.
Gold was another winner from the inflation numbers rallying to a five-month high of $1,868. The precious metal is now being used as a hedge against inflation and the lower real yields move from here the higher gold prices likely to go. The first target to the upside is $1,916 with support around $1,830.