The Week in Review
The major development across global markets last week was the further lift in bond yields, particularly on Friday, following a decent leap in US wage growth within the January payrolls report. Average hourly earnings rose 0.3% to an annual rate of 2.9% – the highest rate in the post-GFC expansion so far. Over the week, US 10-year bond yields lifted 18bps to 2.84%, which was enough to drag the S&P 500 3.7% lower. The Fed meeting by comparison was a non-event, with rates left on hold though with commentary all but confirming the first rate hike for the year will take place next month.
So is this the end of the bull market? No – but a decent correction is way overdue, and worries about bond yields and inflation could be just the catalyst the market needs. As evident in the chart below, from a technical perspective, the US stock market had by end-January become extremely “overbought.”
And while US wage growth may well be lifting, its still coming from a low base – and even this underlying trend appears to have been inflated in January by a few one-off minimum wage increases across a number of States. Judging form past cycles, I’d get a lot more worried about US inflation and a possible end to the US economic expansion and global bull market once US wage inflation hits around 3.5% or more – at which point the Fed would like need to move into restrictive policy mode. In the meantime, we can also expect rising corporate earnings to help underpin the market.
Locally, the key development last week was a slightly softer than market anticipated Q4 consumer price inflation result. All up, annual underling inflation held at around 1.9% – rather than inch up to 2% as expected – which led many to conclude it made it less likely the RBA would raises rates anytime soon. Further supportive of this sentiment, Core-Logic also revealed Sydney house prices softened further in January, with not much offsetting strength in other cities (apart from Hobart!). But while local stocks ended the week higher, futures a pointing to around a 1% drop on Monday morning to reflect Wall Street’s Friday losses.
The Week Ahead
The still broadly encouraging US earnings reporting season took a back seat to the sell-off in bond markets last week, but could regain investor attention this week – though the market will also now keep an increasingly watchful eye over bond yields. Not only are US Q4 earning results generally good, but 2018 earnings are being revised up in light of the recent US tax cut package.
Locally, the key focus of attention will be the RBA policy meeting on Tuesday and its Statement on Monetary Policy on Friday. Despite last week’s seemingly benign Q4 CPI report, I’d note the RBA will consider annual underlying inflation to be around 2% in Q4, which is still a touch higher than its expectation of 1.75% in its November Statement. The issue on Friday, therefore, is whether the RBA now revises up its 2018 underlying inflation projection from 1.75% to 2% – meaning inflation will be projected to least touch the 2-3% target band somewhat earlier than previously expected. If so, there’s a risk the RBA could provide the first tentative move to a tightening bias. Countering this, however, is the upward pressure on the uncomfortably high $A and downward pressure on increasingly fragile Sydney house prices that could be created by such a major shift in RBA messaging at this time.