Equities were marginally higher for the week, with both the S&P/ASX 200 and S&P 500 making new highs again. Both rose just over 0.4%, led by a rebound in tech and growth, whilst cyclicals stalled on the back of lower bond yields despite stronger than expected U.S. inflation. Both the U.S. 10-year and Australian 10-year government bond yields are back below 1.5% as markets viewed another higher-than-expected inflation reading as transitory, given the largest contributors to the reading continue to be supply chain impacted areas like new and second-hand vehicles, or reopening segments like airfares.
The Australian economy remains strong, with the ANZ Job Advertisements survey rising yet again, up by 7.9% over the previous month. The NAB Business Conditions also rose again, though confidence came off a little along with consumer sentiment but both remain at elevated levels.
The G7 conference also made headlines as politicians agreed to pursue an international 15% minimum effective corporate tax rate. However, the proposal remains in its early stages and more details will be required to ascertain the potential impact.
Corporate news flow was dominated by M&A as Altium (ALU) received an unsolicited takeover bid from Autodesk and speculation that Iress (IRE) was also potentially being targeted. This helped the Australian tech sector rally strongly after a poor start to the year.
For this week ahead, we are due for key retail sales and industrial production data from both the U.S. and China. We also receive an update from the U.S. Federal Reserve who will issue their quarterly interest rate projections, a signpost that will be closely watched by markets.
Domestically, we get another employment report that is expected to be strong again given the strength of recent job ads and business survey readings.
Inflation comeback? Bonds say transitory
The past two readings of U.S. inflation has been well above expectations and well above the U.S. Federal Reserve’s 2% target. Base effects would affect the inflation figures relative to the 2% target, but surely base effects have been accounted for in consensus expectations. The bond market, however, reacted with a big shrug of the shoulders for last month’s figure, whilst this month’s reading was met with a leg lower in bond yields, with U.S. yields falling over 0.1% after the news. Either bond markets wholeheartedly agree with the view that inflation pressures will be transitory, or they believe that central banks will continue to heavily support the bond market. After all, a common saying has emerged over the last decade, “Don’t fight the Fed”.
From the chart above, we can see that markets currently sit well away from the historical relationship between inflation and yields. However, if inflation does indeed prove transitory, falling back to the 2% or below level, then we would largely be in-line with historical levels. If consensus is wrong, this would have a very significant impact on investment markets across the board so it is definitely something to watch closely.
Whilst right now the inflation readings are impacted by supply shocks and reopening factors, the area we are watching most closely is rising wage pressures. This has been the missing link over the last 13 years for inflation, as wage growth has been weak. There are early signs that this may be changing as the Biden administration enacts policies to support wage growth and the pandemic has disrupted many segments with lower wages such as those relying on working-holiday travellers or international students. Both in Australia and the U.S., businesses are experiencing difficulties in sourcing workers despite unemployment rates still having lots of slack.
At this stage, we remain in the consensus camp that inflationary pressures do look transitory. However, we think that a structural shift in inflation is also a distinct possibility and have positioned our portfolios with this risk in mind, remaining underweight duration in fixed income and overweight cyclicals in equities.
Tuesday 15 June 2021, 10am
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