Investors are watchful of inflation risks as price levels in the US continued to increase in the month of October.
Core inflation, which excludes food and energy prices, increased by 0.6% month-on-month (MoM), compared to 0.2% in September.
Overall or headline CPI inflation rose by 0.9% MoM, compared to 0.4% prior. On a year-on-year (YoY) basis, core and headline inflation came in at 4.6% and 6.2%, respectively.
The contributors to the acceleration in inflation in October were broad across goods and services. Core goods inflation rose 1.0% MoM as prices for used and new cars unexpectedly picked up again (2.5% and 1.4% MoM, respectively), given the continued delays faced by the auto manufacturing sector.
Household furnishings and supplies was another major contributor, which rose 0.8% MoM. Core services rose by 0.45%, largely due to the ~0.4% increase in price of shelter (homes).
The persistent nature of inflationary pressures put investors in a risk-off mode, as markets waned in the immediate aftermath of the inflation report.
The S&P500 closed Wednesday (10 November) lower, losing 0.82% for the day and 0.31% lower for the week overall. In contrast, the 10-year US Treasury yield, US dollar and gold prices moved higher for the week.
The yield on the 10-year US Treasury bond rose to 1.554% on the day and ended Friday at 1.566% (+11bps on the day and for the week), while the US dollar index (DXY) rose by 0.96% on Wednesday (+0.85% for the week).
Gold prices also rose by nearly 1% on the day and closed off the week at USD1,865 (+2.6% for the week).
The latest inflation print has once again shined the spotlight on the supply chain bottlenecks and challenges that have plagued the global economy since the start of the pandemic.
While inflation has proven to be more persistent than anticipated due to a series of factors since the re-opening began, there are nascent indications that these supply-side disruptions could eventually normalize.
For instance, production capacities across Asia are beginning to normalise – manufacturing capacity in export centres like Shenzhen, Taiwan and Vietnam have reported resumption to over 90% capacity and return of the workforce. In addition, shipping rates from Shanghai to US ports have come off their peaks and the Baltic Dry Index fell by 52% in October.
One key area of concern, however, is wage pressures, which could remain elevated for some time. In particular, the US labour market remains tight as pressures on manpower-intensive sectors like hospitality, restaurants remained high, as shown by the 0.8% MoM increase in the price for restaurant meals (5.3% YoY, the highest reading since 1981).
The US labour market report released on 5 November continued to show no significant improvements in labour force participation, which had remained at 61.6% (same as September). This is 1.7 percentage points below that in February 2020 i.e. prior to the pandemic.
Most of the estimated ~5 million workers that have exited the US labour force are those above the age of 55, but there remained well over 1 million people of prime age (i.e. those aged 25 to 54) who chose not to return to the workforce despite the abundance of jobs.
Lack of childcare alternatives, concerns over Covid risks, and the lingering effects of the generous fiscal transfers from the US Covid relief programme are factors that have delayed the return of workers. For most workers, however, these effects are expected to fade over time.
Over the next few weeks, investors will also grapple with uncertainty over the renewal of Jerome Powell’s term as Federal Reserve Chairman. It has been reported last Tuesday that Governor Lael Brainard was being interviewed to be a potential replacement when she visited the White House earlier.
President Joe Biden had indicated earlier this month during his press conference at the start of the climate meeting in Glasgow that his administration will announce “fairly quickly” the decision on who will lead the Federal Reserve after Chairman Powell’s current term ends next February.
Overall, we see the risks of short-term volatility to be elevated in the remainder of 4Q 2021 as inflation remains a wild card. If officials decide monetary policy needs to be tightened earlier, the FOMC could speed up its tapering, which would allow the Fed to start raising its fed funds rate earlier in 2022.
The risks of a shift by the Fed will support the USD and Treasury yields and test risk assets ahead of the next FOMC meeting.
That said, our macro-economic team does not expect the Fed to change its dovish stance over the near term as the FOMC continues to see supply disruptions easing from the spring of 2022.
This, together with the fact that real interest rates remain firmly in negative territory which has historically been positive for risk assets, underpins our current constructive stance in our asset allocation strategy which takes a moderately risk-on stance via our overweight position in US equities.
We continue to be unexcited about the risk-reward in Chinese equities at present, which underpins our neutral weight position in Asia ex-Japan equities in our asset allocation strategy.
China’s total social financing for the month of October grew at an unchanged pace of 10% YoY. The incremental credit flow in level terms was lower than in the previous month of September.
Amidst the continued slowdown in activities observed in recent months, the lack of significant improvements in credit flows to the economy was a disappointment.
The main contributors to the reduction in pace of increase in credit were a reduction in government bond issuance compared to the previous 2 months, slowdown in net corporate bond financing and medium- to long-term loans to the corporate sector, likely due to the cautiousness around the property sector.
The reduction in government bond issuance was disappointing, as markets had been expecting the government to use fiscal policy in a more aggressive manner to cushion the ongoing weakness in investments and construction activities.
We continue to believe that overall policy to reduce excessive leverage and speculation in the property sector will remain a near to medium term headwind for Chinese risk asset pricing.
The tail risk of severe downside, however, appears limited to us as the government and People’s Bank of China (PBOC) will continue to focus policy support for targeted segments and loosen monetary policy at the margin.
Over the past week, there has been increasing market focus on potential credit easing by the PBOC related to news reports on state media channels including the resumption of onshore issuance for property developers.
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