The Situation of Inflation Today
11 min read
For the longest time, inflation has been the hot topic everyone has been discussing as a result of the Federal Open Market Committee (FOMC) meeting last Wednesday. In last week’s market roundup, we discussed the immediate impact of the Federal Reserve’s announcement on its biggest rate hike in a bid to slow the soaring inflation, with half a percentage point increase. The announcement led to an almost immediate rally in markets across the globe. However, soon after, we witnessed a downturn in the markets yet again. This volatility has proven to wrecking markets all over the world. US stocks have suffered the worst streak of weekly losses in more than a decade following days of turbulent trading surrounding the Fed’s latest decision. In this week’s monthly issue, we examine how the market’s reactions have swung to the other end of the pendulum, as well as the implications of inflation being a debacle that is extending to an almost global scale.
The US Stock Market
Wall street ended lower last Friday amid concerns about rising Treasury yields and the prospects of more Fed rate hikes. Investor sentiments are slanted towards concerns that the Fed’s interest rate hike would not be enough to tame the surging inflation. In fact, all three main Wall Street benchmarks had expunged the gains made during a relief rally on Wednesday last week, and this includes large technology giants like Google parent Alphabet, Apple, Microsoft, Meta Platforms and more.
It is not just high-growth stocks which have suffered from investors’ concerns over future earning potentials in face of rising rates. The self-off hit all areas of the market as we witnessed traders dropping out. Experts reckon that investors’ sentiments are mainly driving the markets, as opposed to fundamentals, such as earnings. When the Feds raised interest rates last week and explicitly ruled out a hike of 75 basis points (bps) in the June meeting, market sentiments were stirred up, with traders projecting a different view. Traders have raised their bets on a 75 basis-point hike at the Feds in the coming meeting and the lines are blurred with the situation, causing much confusion amongst investors as well.
According to preliminary data as of Monday this week, S&P500 lost 148.70 points to close at 4,419.31 points, while the Nasdaq Composite lost 635.21 points to end at 12,329.65. As for the Dow Jones Industrial Average, we witnessed a decline of 1,033.07 points to 33,027.99. All the 11 major S&P sectors faced a downturn, with consumer discretionary leading the way. The technology sector has also slumped, with the rest of the markets.
Overall, we are seeing those areas of the market which are purely discretionary getting hit as everyone is anticipating that this is going to be a challenging period for consumers over the next several quarters. Let’s now shift our focus to the US Labor Department.
The US labour market
The Labor Department presented stronger-than-expected jobs data with nonfarm payrolls increasing by 428,000 jobs in April, as opposed to the expectations of 391,000 job additions. This underscores the economy’s strong fundamentals despite a contraction in gross domestic product (GDP) during the first quarter. The unemployment rate has remained unchanged at 3.6% in the month, while average hourly earnings increased 0.3% against a forecast of a 0.4% rise.
The wage data has created greater concerns over persistent inflation, pushing the Treasury yields up to 3.1% while dragging stocks lower. The dollar index, which tracks the US currency against six others, hit a fresh 20-year high on Friday. Ongoing wage pressure can be an indicator that inflation is becoming entrenched in the system and this is worrying as we wonder where the interest rates will eventually rise to. Eventually, we might end up with yet another round of decline in the stock market within the next few quarters.
Despite having no unanimity in the overall market direction since last Wednesday, one thing investors do agree on would be the extreme fluctuations in prices being the outcome of heightening volatility that has been apparent for most part of the year. Pundits are also reckoning that there might very well be no end in sight.
Europe
The situation of inflation in Europe is also troubling, especially after the outbreak of the Ukraine war. As of April, energy prices have been standing at 45% above their level one year ago, continuing its position as the main factor for the high rate of inflation. Germany, for one, is about to face a huge problem with energy sources. Russia is its top energy supplier, with Germany paying over $200 million per day as energy costs, money that is financing the war at present, something that is certainly causing the Germans to feel rather distasteful. As such, we will probably be witnessing a far greater soar in energy prices when Germany has to look for alternative and more costly avenues for energy. Food prices have also increased partially due to surging transportation and production costs, especially the higher prices of fertilisers, which are in part due to the war. Supply bottlenecks and the resumption of demand as the economy reopens continue to put upward pressure on prices.
According to the hawkish policymaker Robert Holzmann, the European Central Bank should hike interest rates as many as three times this year to withstand inflation. These increases could also be smaller ones, like 25 bps each. In this manner, the effect by 2023 would be that the deposit rates for banks, currently standing at minus 0.5%, could end up in the positive territory. Although it is still a fair bit away from the natural nominal interest rate, it will still be a good signal to the public, overall.
The Fed’s move to raise rates by half a percentage point supports the dollar against the Euro and this could fuel imported inflation. As such, this may cause a problem for Europe. The ECB does not pursue an exchange rate target, but they have claimed to be watching the situation closely and taking the Fed’s actions into consideration when they make their moves as well. As of now, it will probably be difficult to compensate for the difference by merely raising interest rates, but the ECB is at least maintaining the gap.
Europe’s labour market
As for the labour market in Europe, it continues to improve as unemployment falls to a historical low of 6.8% in February. There is also a robust demand for labour, but wage growth remains muted overall. With inflation ongoing, the lack of growth might not be too much of a concern as we would not want wage push inflation to come into play if the labour market flourishes too quickly and wage rise becomes difficult to manage with the ongoing inflation at play. A wage-price spiral which will subsequently demand for higher salaries could lock in inflation, creating a dangerous situation for Europe. But the ECB is claiming to be scrutinising wage settlements, and if the danger does arise, the ECB would raise interest rates more strongly to avoid possible second-round effects that could really harm the real economy. In any case, the situation is safe as of now.
Back here at home
Asian countries are also experiencing inflation, though not at a rate like that of the Western regions, but it is indeed catching up in Southeast Asia. We are experiencing rapidly increasing prices of food, energy and services that could very well compel the region’s central banks to raise interest rates sooner than expected. In fact, right here at home, the Monetary Authority of Singapore (MAS) core inflation increased to 2.3% year-on-year in the start of 2022, from 1.7% in Q4 2021. This mainly reflected rising electricity and gas, as well as non-cooked food inflation, driven largely by higher global oil and food prices. In the quarters ahead, consumer price inflation in Singapore will rise further than what was previously anticipated as we experience higher global commodity prices and renewed supply chain disruptions as a result of both the ongoing Ukraine war and the pandemic.
With the situation of the pandemic gradually improving as the country stabilises, we are experiencing a high level of pent-up demand for discretionary expenditure and this could lead to greater pass-through of accumulating business costs. Singapore’s resident unemployment rate has declined to pre-pandemic levels and is expected to remain low. The overall labour market will remain relatively tight, with resident wages kept well supported. Consequently, the resulting unit labour cost increases will be a key contributing factor to the underlying inflation.
MAS Core Inflation is now projected to come in at 2.5% to 3.5%, from the 2.0% to 3.0% expected in January. Meanwhile, CPI-All Items Inflation is forecast at 4.5% to 5.5%, from the earlier range of 2.5% to 3.5%.
With the underlying inflationary pressures remaining a risk over the medium term, MAS has decided to further tighten monetary policy in two ways. First, MAS will re-centre the midpoint of the exchange rate policy bank at the prevailing S$NEER. Second, MAS will increase the rate of appreciation of the policy band slightly to suppress inflation. There will be no changes to the width of the policy band. This tighter monetary policy position will slow down the inflation momentum and help ensure medium-term price stability. We can only hope for MAS to maintain a cautious and watchful approach when it comes to monitoring the external economic environment and their impacts on the local economy.
Trader’s View
The US Dollar index (USDX) has reached a high since 2017, with expectations of more upcoming rate hikes by the US Federal Reserve. The US dollar index is a measure of the US dollar relative to a basket of foreign currencies which includes the Euro, Japanese Yen, Canadian dollar, British pound, Swedish krona and Swiss Franc.
With the US Dollar index at the peak since 2017, currencies pairs like USD/JPY, USD/CHF and USD/CAD are currently trading at a near term peak while EUR/USD and GBP/USD are at near term bottom.
We shall explore USD/JPY as a reference.
USD/JPY Monthly Chart
As we can see from the above chart, USD/JPY is currently trading at around 130.07. We can see an inverted head and shoulder formation from 2002 till date. USD/JPY has broken the neckline of the head and shoulder formation, hence we will be expecting bullishness in USD/JPY aligning with the fundamental view of strong USD. For a longer term view, we may see a possible target of around 135.25.
Let’s look into a 4-hour chart below.
USD/JPY 4 Hour Chart
From the 4-hour chart above, we can see a channel formation. Currently, the price is trading around the lower channel zone. If the lower channel for USD/JPY holds, we will be expecting USD/JPY to head towards near term resistance at the 131.33 zone. Subsequently, we will be expecting USD/JPY to break the zone in the mid term.
