(Updates with Friday prices)
By Chuck Mikolajczak
NEW YORK, Feb 9 (Reuters) - The inflation bogeyman has
reared its ugly head and sent U.S. stock investors racing for
the hills in recent days.
Next week, coming off one of the most volatile stretches in
years, two important readings on U.S. inflation could help
determine whether the stock market begins to settle or if
another bout of volatility is in store.
If the January's U.S. consumer price index due next Wednesday
from the U.S. Labor Department, and the producer price index the
next day, come in higher than the market anticipates, brace for
more selling and gyrations for stocks.
U.S. consumer prices rose 2.1 percent year-on-year in
December and is forecast to stay around that pace this month.
"If we get a hot CPI print it will insert additional
uncertainty, but if we get a quiet, below-consensus print, you
may see yields down and equities rally," said Jason Ware, Chief
Investment Officer & Chief Economist at Albion Financial Group
in Salt Lake City, Utah.
The equity market has become highly sensitive to inflation
this month. A selloff in U.S. stocks earlier this week was in
large part sparked by the Feb. 2 monthly U.S. employment report
which showed the largest year-on-year increase in average hourly
earnings since June 2009.
Recent U.S. tax cuts that may spur economic growth, the
prospect of more government borrowing to fund a widening fiscal
deficit, and rising wages, have all pushed up benchmark U.S.
Treasury yields to near four-year highs.
"This is how we started, go back to Friday and this is
exactly where we were," said Art Hogan, chief market strategist
at B. Riley FBR in New York.
"The conversation about equity risk premium, interest rates
and inflation, we are coming full circle."
The jump in wage inflation pushed yields on the benchmark
10-year U.S. Treasury note closer to the 3.0 percent
mark last seen four years ago, denting the attractiveness of
equities, and unnerving investors fearful inflation will force
the U.S. Federal Reserve to raises short term interest rates at
a faster pace than is currently priced into the market.
The current earnings yield for the S&P 500 index companies
stands at 5.4 percent, below the 6.4 percent average of the past
20 years. As bond yields rise the spread between the two
narrows, prompting asset allocation changes between equities and
Investor concerns over inflation was reflected in Lipper
funds data on Thursday, which showed U.S.-based
inflation-protected bond funds attracted $859 million over the
weekly period, the largest inflows since November 2016.
On Thursday, New York Federal Reserve President William
Dudley said the central bank's forecast of three rate hikes
still seemed a "very reasonable projection" but added there was
a potential for more, should the economy look stronger.
Traders are currently putting the chances of a 25 basis
point hike by the Fed at its March meeting at 84.5 percent,
according to Thomson Reuters data.
Benchmark 10-year note yields this week rose to
a four-year high of 2.885 percent. On Friday, benchmark 10-year
notes last fell 1/32 in price to yield 2.853
While many analysts were predicting bond yields to rise this
year as global economies improve, the suddenness of the move was
a large factor in the recent stock market selloff.
The 10-day correlation between the S&P 500 index and yields
on the 10-year note was at a negative 0.79, as of late Thursday.
On Friday, both the Dow Jones Industrial Average and S&P 500
index closed out their worst two-week performance since August
"The pace really does matter," said Ron Temple, Head of US
Equities and Co-Head of Multi Asset Investing at Lazard Asset
Management in New York.
"If we see 3.0 percent next week that is going to spook
people more - the equity market psyche is fragile at this
The fragile investor psyche is likely to lead to continued
volatility coming off a week that saw the Dow suffer its largest
intraday index point decline in history on Monday, nearly 1,600
points. The Dow currently has an average intraday swing over the
past 50 days of 265.76 points, the highest since March 2016.
While volatility has subsided a little from the heights
touched earlier this week, it is far from an all clear, Nigol
Koulajian, chief executive of Quest Partners, a New York-based
systematic commodity trading advisor with $1.4 billion in assets
under management, said.
Koulajian pointed to the fixed income market as the main
catalyst right now for near-term moves in the stock market.
"Investors need to keep a very, very close eye on fixed
income," he said. "The catalyst needn't be big. When the market
is this levered, even tiny events can trigger a big avalanche."
But analysts also caution yields are not at levels that
should be alarming to investors, and in fact are at levels that
signal a healthier global economy, and the performance of some
stocks this week points to a belief the consumer is also getting
The average yield on the 10-year Treasury note over the past
30 years is 4.834 percent, still well above current levels.
"Fundamentals are still positive, there is strong economic
growth and strong earnings growth - those will help stocks move
higher over time," said Kate Warne, investment strategist at
Edward Jones in St. Louis.
"But it doesn't do much for predicting short-term moves."
(Additional reporting by Megan Davies, Saqib Iqbal Ahmed and
April Joyner; Editing by Alden Bentley and Clive McKeef)
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