Stocks head south after surging US inflation

Stocks are heading southwards on fears of a more hawkish Fed, after US CPI hit 7.5%. The UK economy held up better than feared in December 

• US CPI rose by more than expected, fueling bets of a more hawkish Fed
• USD is rising whilst US indices are pointing to another day in the red
• UK GDP in December was better than expected, despite Omicron hit

Wall Street closed sharply lower yesterday, with the Nasdaq bearing the brunt of the pain, following the release of US inflation data. The risk off mood after the release has followed through and is weighing on European futures ahead of the open today, despite UK Q4 GDP holding up better than expected.

US CPI jumped to 7.5% YoY in January, up from 7% in December and well above the 7.3% forecast. Core inflation, which strips out more volatile items such as food and fuel rose 6% YoY. The 40-year high inflation sent 10-year treasury yields surging above 2% for the first time in years. 

Higher yields suggest that the market is pricing in a more aggressive Fed. Not only is the market pricing in up to 6 interest rate rises from the Fed this year, but expectations for a 50-basis point hike in March have also risen sharply, up from the previously expected 25 basis point hike. 

Highlighting the more hawkish stance expected from the Fed, James Bullard the St Louis Federal Reserve President said that he wants to see a 1% interest rate hike in place before that start of July. He also suggested that the Fed could need to schedule an emergency meeting to hike rates sooner than March. Not only is inflation at a 4-decade high, it is hotter than expected but there is still a month until the next Fed meeting.

US indices drop, USD rallies

Following the release, US stocks tumbled lower, with the tech heavy Nasdaq taking the biggest hit. US futures are pointing to a weaker open again today. Although, thanks to a stronger start to the week, US indices may be able to squeeze out gains across the week.

The reaction to hotter than forecast inflation is also being played out in the FX market. USD/JPY touched a fresh year to date high and the greenback continued to advance versus its major peers after a lot of turbulence immediately after the release, which at one point saw the dollar hit new weekly lows.

The Aussie is underperforming after cautious comments from RBA Governor Philip Lowe overnight which highlighted the central bank divergence with the Fed.

UK GDP not as bad as feared

The UK economy held up better than expected in the final three months of the year. The GDP fell by -0.2% in December, better than the -0.5% contraction forecast. On a quarterly basis the GDP grew by 1% QoQ, the same as in Q3 despite the Omicron hit to the economy in December. The UK economy remains at the same size that it was just before the pandemic hit. 

Across the year the UK economy grew 7.5% in 2021 after a 9.4% contraction in 2020. This marks the strongest level of growth since the second world war. However, this level of growth is not expected to continue, especially given the strain on household finances as inflation rises to a 30 year high.

FTSE rises from the lows

The FTSE, after reaching two-year highs in the previous session is expected to start lower today. That said the FTSE futures have picked up off session lows. The pound is pushing higher versus the euro following the encouraging GDP data but is still struggling against king dollar.