Inflation (CPI), The Fed & ECB – FinTwit Trends To Watch

UNSURPRISING INFLATION DATA SETS UP SPECULATIVE TALKS FOR NEXT WEEK

Inflation was the talk of the week with actual figures coming in above estimates (see economic calendar below). The recent hype about soaring inflation strangely had minimal impact on financial markets with volatility remaining fairly passive. Many analysts who agree with the “transitory” standpoint by the Fed can find solace in the fact that while inflation numbers are high, the major contributors are a handful of products such as lumber and automobiles.

U.S. inflation data:

US inflation data

Source: DailyFX economic calendar

Widespread inflation across many products would cause greater concern of an overheating economy and may lead to intervention from the Fed. For now, the central bank is likely to continue on it’s the current path of average inflation targeting as well as refute any rumors of tapering just yet. Next week's Fed interest rate decision (June 16th) will be more geared toward identifying any possible (but unlikely) suggestions of changes in forward guidance.

U.S. 10-YEAR TREASURY YIELDS TUMBLE AHEAD OF FOMC MEETING

Following on from the aforementioned inflation data, U.S. treasury yields reacted in a less obvious manner. Generally, when inflationary pressure rises, bond yields tend to rise with it in order to compensate for this inflation risk and depressed bond returns (see chart below). However, this week saw the opposite as reflected by the highlighted area on the chart. So why would bond market participants jump at the chance to buy U.S. Treasuries at yields of roughly 1.5%?

There are a few possible reasons for this:

  1. U.S. treasuries are comparatively higher than other nations sovereign bonds which has maintained demand thus suppressing yields.
  2. The Federal Reserve is purchasing massive quantities of Treasury bonds every month.

Does this mean the bond market is supportive of the Fed and it’s policy of a brief spout of high inflation? Next week’s meeting should give a clearer picture of the way forward.

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