Today's Markets: Stocks continue downward trajectory after hot inflation report

Inflation sinker: Friday’s CPI inflation print truly stung the market, sending the S&P 500 down 3 per cent on the session to complete its worst week since January. The broad market fell 5 per cent last week, its ninth down week in ten. European stock markets fell 1.5 per cent early Monday following the drubbing. Asian markets tumbled overnight, and US stock futures are lower too with the S&P 500 seen opening just a whisker above the May 20th low at 3,810. It’s been blanket selling since the inflation report, not helped by China extending lockdowns in a number of cities as they struggle to stamp out Covid. 

Markets seem to be saying central bankers are going to need to do more, whilst the ‘inflation has peaked’ narrative was killed. Whilst prices for bellwethers including fertiliser, computer chips and shipping containers have declined lately, and Chinese producer prices are rising less quickly, it’s clear that consumer inflation is still hot and wages could spiral to make it worse. The path to a soft landing is getting even narrower.

Bond yields are on the move: German 2yr rose above 1 per cent for the first time since 2011, whilst the US 2yr rose to its highest since 2007 as markets repriced Fed rate hike expectations higher. That inflation report did one very clear thing: raise expectations for the Fed to hike more and quicker. We don’t know whether the ECB is going stiffen its stance… last week the announcement to raise rates next month only saw spreads widen. This morning the spread between 10yr Italian and German paper widened further, to 237bps, with BTPs up to 3.88 per cent. The euro is weaker today, with EURUSD under 1.05. 

The Bank of England this week is under heaps of pressure – today's GDP report showed the economy shrank in April and inflation is going to be the worst in the G7... Bailey talks of a narrow path which has sounded kind of soft, but there is only one way to smash this inflation. The Fed gets it, the rest are more unsure. With US yields rallying and a broad de-risking effect, the dollar is bid. GBPUSD is back at the 1.22 area. UK plans to rip up the Northern Ireland protocol don’t help sentiment but we should stress that this looks more like a broad dollar move. Market pricing for the bank rate at 3 per cent by the end of the year is quite hawkish… the BoE has not been signalling it will go that hard but it might be forced to catch up.

The Federal Reserve is the highlight this week and it could become more aggressive even than the 50bps hike that is expected. The Fed could surprise with 75bps this meeting, although if not we could see some commentary from Powell to guide for September. Currently the market is braced for 50bps in both June and July but is less sure around September. So, if Powell guides towards a further 50bps hike in September that could be viewed as hawkish. Goldman Sachs: "We now expect the Fed to hike the funds rate by 50 bps in September (vs. +25bp previously), in addition to +50bp moves in June and in July." Fed Funds now implicitly expected to top 3.25 per cent at February's meeting. 

It wasn’t just the inflation report. The closely watched University of Michigan survey showed consumer sentiment declined by 14 per cent from May, reaching its lowest recorded value, comparable to the trough reached in the middle of the 1980 recession. Soaring gasoline prices, which have topped $5 a gallon, were a chief concern mentioned by respondents. This collapse in consumer confidence seems entirely inflation related since the labour market remains in good strip. What happens though when the Fed breaks the economy? It can get worse.

Elsewhere, the yen fell to a 24-year low against the US dollar – Bank of Japan this week but don’t expect it to veer towards a more hawkish stance. There was a joint statement from the BoJ and Ministry of Finance on Friday expressing concern about the decline in the yen, but the market is going to test their resolve and it could go a lot lower. We had some more jawboning from BoJ governor Kuroda this morning, saying the depreciation in the yen is undesirable. 

Contagion: Bitcoin is also lower... no inflation hedge, just a correlated risk asset and a bad one at that. Does MicroStrategy (MSTR) keep averaging down? MicroStrategy's cost basis was roughly $30,700 per Bitcoin, according to its first-quarter earnings report. This morning prices are south of $25k, hitting an 18-month low. Crypto network/DeFi lending company Celsius (CELH) has halted withdrawals due to market conditions. Things are breaking in the crypto space and it will get messier. 

Neil Wilson is the Chief Market Analyst at markets.com