Week Ahead: Rising Headwinds From Inflation, Rates, Geopolitics To Amp Volatility

Inflation data blew past expectations, pressuring Fed to increase tightening
The US warns of retaliation if Russia invades Ukraine

With the same risk themes still in play, along with the added possibility that “the West would respond decisively to any invasion of Ukraine,” according to US President Joseph Biden during a call with Russia’s Vladimir Putin on Saturday, we don’t expect market volatility to ease in the coming week. As of this writing, both the US and the UK have called for their citizens to leave Ukraine.

Indeed, with the tailwind of earnings season winding down, and after last week’s hotter than expected US CPI release—the highest level of inflation escalation in decades—plus interest rate hikes on the horizon, investors rapidly reacted to the rising headwinds and flipped to risk-off as the trading week came to a close.

Markets Drop As CPI Overheats; Cyclical Rotation Escalates

The consumer price index climbed another 0.6% in January, bringing the YoY reading to 7.5%, the sharpest rise since February 1982. As well, the Fed’s preferred metric, core inflation—which excludes mercurial energy and food prices—rose 6%, beating estimates.

At the same time, even when discounting inflation, real wages gained 0.1%, and weekly Initial Jobless Claims fell to 223,000, below the 230,000 forecast. Rising wages and lower unemployment are additional, contributing factors to escalating inflation, as more people working for better pay will likely increase demand for goods.

Last month, stocks retreated from record levels after Jerome Powell shocked markets by pivoting from a dovish to a hawkish stance. Dramatic volatility, which included the worst equity market selloff in years, led to an array of Fed speakers stepping up to soothe investors, saying rates won’t be increased as quickly as markets may have feared.

That helped bulls get back into the market. But will the Fed be able to keep such promises? Whatever policymakers might say, their mandates will require them to manage inflation in order to keep it from getting out of hand. And that means raising interest rates as frequently and steeply as required, notwithstanding how investors feel about it. If they don’t rein in inflation, the US economy could go into recession, leading to a possible market crash.

All four major US benchmarks—the Dow Jones, S&P 500, NASDAQ and Russell 2000—dropped on Friday. The tech-intensive NASDAQ 100 was the biggest loser, plunging 3.07%.

Big tech’s underperformance is in line with a cyclical rotation amid rising rates, as investors punish the most highly valuated stocks first. In a mirror image, indices representing value shares outperformed. The Russell 2000, whose small cap firms rely on economic growth, retreated ‘only’ 0.89%, providing the best results among index peers, after a long stretch of being the consistent laggard. The blue chip Dow, which lists the 30 biggest US companies, followed, declining ‘just’ 1.43%.

The S&P 500 dropped 1.9%, pulled lower primarily by Tech stocks, as the sector plunged 3.05%. Energy, an economically sensitive sector, outperformed, adding 2.91%.

The same performance relationship between growth and value sectors also occurred on a weekly, monthly, and three-month basis. The market looks to be in full cyclical rotation mode.

The NASDAQ 100 may also be completing a bearish technical pattern.

NDX Daily

The index looks top-heavy. It may have completed a rising flag, bearish after the initial plunge, which could also be the right shoulder of a down-sloping H&S top, which didn’t have enough demand to create a symmetrical right shoulder.

As well as weighing on equities, the shocking inflation data pushed investors to rotate into Treasuries, sharply pressuring yields, including for the 10-year benchmark.

UST 10Y Daily

Yields are probably performing a return move toward a bullish symmetrical triangle, itself a breakout of a much larger bullish symmetrical triangle. These patterns highly suggest additional advances for yields, which are seen driving down stock prices, as higher rates render shares more expensive so that higher bond yields provide a more attractive investment.

The dollar gained on Friday for a second day. The greenback closed at the height of the session.

Still, geopolitics helped pushed gold to its sixth winning day.

Gold Daily