Hot UK inflation print adds fuel to BoE rate bets, lifting pound
Yen gets scorched by revival in US yields, but dollar can’t rally
Stock markets in cheery mood ahead of Tesla (NASDAQ:TSLA) earnings today
Sterling capitalises on inflation scare
The British pound was in a jolly good mood on Wednesday after the nation’s latest inflation report came in hotter than expected, cementing investor bets that the Bank of England will keep raising interest rates to put the inflation genie back in the bottle.
Consumer inflation in the United Kingdom clocked in at 10.1% in March, a cooldown from the previous month but well above what economists had projected. Similarly, the core rate remained unchanged at 6.2%, defying expectations for a slowdown. Coupled with yesterday’s jobs report that revealed stronger wage growth, it seems the inflationary impulse is regaining force.
Market participants responded by fully pricing in another quarter-point rate increase at the BoE’s next meeting in May, with the central bank now expected to raise rates by a total of 75bps by the fall before moving to the sidelines. This was music to the ears of the British pound, which stormed higher to record some solid gains, especially against the Japanese yen.
Moving forward, however, it’s tough to be optimistic on sterling. Several further rate increases are now baked into the cake, which might come back to bite the pound if the data pulse weakens and the BoE underdelivers. Most importantly, Cable has returned to its old habits of tracking stock markets, having an 86% correlation with the S&P 500 over the last month. Hence, any selloff in equities could be quite damaging.
Dollar steady, yen slumps
In the broader FX complex, the wounded US dollar has managed to regain some footing with some help from a rethink around the Fed’s interest rate path. Markets currently assign an 85% probability for the Fed to raise rates in May, while bets of rate cuts later this year have been mostly unwound as incoming data implied the US economy is not rolling over.
The striking part is that the dollar could not recover properly, and has simply managed to stabilise despite this Fed repricing. The dollar's inability to rally suggests the overarching narrative hasn’t changed - investors still anticipate heavy rate cuts, only the timing has been pushed back into next year.
While the recent spike in US yields hasn’t done much to boost the dollar, it has inflicted damage on the Japanese yen. Pairs such as euro/yen and sterling/yen have gone berserk this past month, as recession fears subsided and expectations about imminent tightening by the Bank of Japan faded.
Stocks fare well despite uncertainty
Over in the equity arena, there’s still a sense of exuberance in the air. Any dips are shallow and get bought quickly, valuations have reached extreme levels, while the VIX ‘fear gauge’ has been crushed as investors remain reluctant to buy downside protection. This is a market that is not afraid of any shocks.
The prevailing narrative is that the economy has been more resilient than expected, the Fed is about to ease off the brakes, and corporate earnings have exceeded expectations so far. In reality, it’s probably the tsunami of liquidity that was unleashed after the banking episode that did the heavy lifting.
Once this liquidity impulse weakens and the ‘sugar high’ fades, investors will need to grapple with how stretched valuations have become heading into an earnings recession, as corporate profits are set to contract for a second quarter in a row. Therefore, the upside for stocks seems limited from here, whereas the downside could be severe.
As for today, the earnings show will continue with Tesla releasing its results after Wall Street’s closing bell.