US Close: Stocks slump as inflation fears drive Fed rate hike expectations, Dollar follows Treasury yields

US stocks are sliding as surging pricing pressures have the Fed on a fast-track to get rates back to neutral.  Every trader over the weekend read the Goldman note that eyed four Fed rates hikes and balance sheet runoff in July, if not sooner. Surging yields are kryptonite for many tech stocks and that theme won’t change until after we get past the first couple rate hikes.

Today is all about risk aversion as fears grow that financial markets completely misread the Fed’s scramble to battle inflation. Even cyclicals are struggling as the White House and Senator Manchin seem nowhere closer to getting Build Back Better done.  Over the weekend, the Washington Post reported that Manchin’s $1.8 trillion social-spending blueprint appears to have been pulled.  The Biden administration knows this will be the last major piece of legislation that will get done before the midterm elections and something needs to get done over the next month.

Despite all the concern with inflation and there still be a lot of froth in the market, US stocks, in particularly cyclicals should do well over the short-term.  The Nasdaq is already down over 6% in January, but that might not last as mega-cap favorites such as Microsoft, Alphabet, and Amazon could have very strong earnings.

Focus on Inflation

The latest round of pricing pressures is being felt a bit more by a lot more Americans.  Labor shortages with truckers, warehouse workers, and a wide range of manufacturing jobs suggest the peak in price hikes is going to get very ugly.  The supply chain situation is leading to many empty grocery shelves across several supermarkets. The key data point this week will be Wednesday’s US inflation report.  US inflation is expected to post an annual increase over 7.0%, which would be the strongest reading in almost four decades.  Wall Street has become very confident that the Fed can go ahead and raise rates in March and this inflation report will likely confirm the growing belief that four rate hikes can happen in 2022.

FX

Despite growing optimism abroad for European assets, surging Treasury yields and risk aversion on Wall Street has the dollar making a strong run.  Now that the US economy is basically at full employment and with inflation still running hot, the scramble for rate hikes seems like the dollar could still be king a little while longer.

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