Something doesnt quite add up

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By :  ,  Financial Analyst

A lot of investors and analysts were left scratching their heads after yesterday’s dramatic moves in the markets. We were one of those. Something doesn’t quite add up, with stocks and yields being up and the dollar lower at a time when global inflation is on the rise and central banks about to become more aggressive in hiking interest rates. Usually, rising yields are not good news for commodity FX, so the rally in the AUD/USD or the USD/CAD sell off doesn’t quite make sense, nor does the rally in the stock markets, but then when was the last time equities behaved as they ‘should’? US inflation figures yesterday showed consumer prices rose more strongly than expected in January, keeping the year-over-year rate at 2.1% and the core at 1.8%. While retail sales were quite poor, the market didn’t seem to care much as the inflation data fuelled expectations that the Federal Reserve will raise rates more aggressively this year than had been expected and the probability of a March hike rose to 100%. The benchmark yield on the 10-year US Treasury rallied to a fresh four-year high and was up again at the time of this writing on Thursday. To say the moves in the other markets surprised us is an understatement. The dollar sold off heavily after an initial pop, while stock indices surged after a sharp initial decline. So, bond prices decoupled from stocks, while the dollar also refused to go up in tandem with the rising yields. While part of the reason for this breakdown may well have been those disappointing retail sales data, it could be that investors are looking elsewhere for investment as the global economy recovers. Demand for foreign currencies has led to sizeable gains for the likes of the EUR/USD and JPY/USD as the European Central Bank and the Bank of Japan begin preparing to normalise their respective monetary policies. The Bank of Canada has already started raising rates and there may well be more hikes to look forward to from the Bank of England this year. On top of this, the Fed’s projected rate hikes has already been mostly priced in before the inflation data came out anyway. Furthermore, the dollar’s woes may also reflect in part concerns over the ballooning US debt levels and some loss of trust in the government. Still, all that being said, something doesn’t quite add up. If bond yields are refusing to fall then surely we will have to see a strong dollar rebound and a possible stock market sell-off. On the other hand, if the dollar wants to go lower and stocks higher, then yields need to fall back. It is also possible that I am completely wrong about something here, and maybe I am reading too much into it. In any case, I, for one, will remain on the side-lines until I see some clarity.

Related tags: Bonds Forex

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