WIKIFX REPORT: Inflation is the key topic in the market right now

Inflation is a measure of the rate of rising prices of goods and services in an economy. If inflation is occurring, leading to higher prices for basic necessities such as food, it can have a negative impact on society.

Virtually every financial market has been grappling with the specter of inflation in recent months. This looming concern has drawn the focus of the US Federal Reserve, among other central banks, prompting concerns in the short- medium and long-term.

Central banks of developed economies, including the Federal Reserve in the U.S., monitor inflation. The Fed has an inflation target of approximately 2% and adjusts monetary policy to combat inflation if prices rise too much or too quickly.

Many of the largest world economies are presented with a unique issue. Re-opening or returning to employment at the same time and quickly. This is particularly problematic given a run on all matters of commodities and goods, causing a rise in inflation.

These worries have been on full display during the past several months, during which Federal Reserve Chairman Jerome Powell has spoken at length on the issue. This is hardly just a US issue however, with European markets experiencing similar concerns.

While Powell has sought to calm markets and assure that inflation is within an acceptable range, market investors are not quite sold.

This is evident based on a number of recent selloffs and jitters roiling global markets recently, including equity, metals, and commodities markets, among others.

All Eyes on Bond Yields

The bond market is a great predictor of inflation and the direction of the economy, both of which directly affect the prices of everything from stocks and real estate to household appliances and food. Bond yields globally and have been on the rise in 2021, leading to some of the largest single-day market pullbacks not seen since the previous year.

Indeed, abrupt rises in 10-year US bond yields in particular have been one of the most potent drivers of markets over the past two months. A rise in these yields is disturbing investors that the Federal Reserve will have no choice but to start hiking interest rates, now at historic lows.

A move likr this would be a massive blow for equity markets in the US. Other countries are facing similar situations as well, with inflation widely floated as one of the most concerning issues, other than Covid.

Also, the Consumer Price Index in the US has also been rising, which measures the average change over time in the prices paid by urban consumers for a market basket of goods.

Analysts had been forecasting a higher annual increase as of late, namely when weighed vs. last April when global economies essentially were reduced to a standstill. However, the latest CPI readings in the US during the past two months were well above estimates. This recent reading in April in the US had an obvious and immediate effect on long-term Treasury bonds. Rates for the 10-year Treasury note rose to 1.695%, reversing off a recent decline.

Why Rising Interest Rates Could Stop the Party

Higher interest rates reduce demand for goods and services, which makes it harder for companies to raise prices. Investors have been disturbed about rising interest rates for some time. Much of the recent market strength in US indices has been attributed to rock bottom interest rates, which has led to a groundswell of liquidity.

Long-term Treasury yields are primarily driven by expectations about both inflation and how the Fed may shift interest rates.

Should bond yields creep up too high as a result of inflation, this would ultimately force the Feds hand in taking monetary policy action.

Recent selloffs have recently incurred a roughly 2% or less decline in the S&P 500 and other major indices. However, these moves were predicated on fears of rising yields. Any actual change or worse, surprise decision by the Fed to hike rates would be a massive blow to investor confidence.

Perhaps more so than any other lingering concern for markets, mounting inflationary fears are the most troublesome. US equity markets have already been in overdrive for 2021, with the only respites in advances seeming to be checked by rising yields.

Even assets that traditionally have been the beneficiaries of inflation such as precious metals have been unable to escape the market carnage wrought by rising yields. Both gold and silver have consistently declined with rising yields. This is due to the prospect of rising interest rates and a higher US dollar, a net negative for metals.

Nearly all investors should be cognizant of any changes in bond yields moving forward, which will inform any decision-making by the Fed. For now, analysts are hoping for normalized inflationary readings and nothing too groundbreaking as to force the Fed into action.