Carlos Jasso/Agence France-Presse/Getty ImagesPersistent double-digit inflation in the U.K. is raising fresh questions in U.S. markets about whether traders and investors are once again off the mark about the most likely trajectory for price gains. The U.K.’s year-over-year 10.1% rate for March marked the seventh straight month that inflation has been in the double digits. It’s also the highest level of any country in the Group of Seven, which also includes the U.S., Canada, France, Germany, Italy, Japan. As Danni Hewson, head of financial analysis at AJ Bell, put it: “Once again, expectations that U.K. inflation would finally fall to single digits for the first time since last summer have been dashed.”Bond markets reacted to Wednesday’s data by sending yields up in the U.S.: The policy-sensitive 2-year yield BX:TMUBMUSD02Y and the 10-year benchmark rate BX:TMUBMUSD10Y jumped to one-month highs of 4.26% and 3.6%, respectively. Meanwhile, Dow industrials DJIA and the S&P 500 SPX finished lower, while the Nasdaq Composite COMP eked out a tiny gain, as investors also weighed another batch of earnings results.The question at the core of the market’s thinking at the moment is whether inflation will evolve in a fundamentally similar or different manner across countries. Strategists at BMO Capital Markets have raised the risk of an outlier scenario in which recent moderation in U.S. inflation “stalls, making price stability elusive”; even so, they said the U.K.’s data didn’t give any additional weight to that case on Wednesday.At Deutsche Bank, senior economist Sanjay Raja said the firm now sees “clear upside risks” to its forecast of how high the Bank of England will end up raising rates, and now expects a 4.75% policy rate by June.Many traders are continuing to cling to a consensus view that U.S. inflation should fade as economic growth slows: In fed funds futures, they are mostly pricing in rate cuts by year-end from the Federal Reserve after one or two more rate hikes. In derivatives-like instruments known as fixings, inflation traders expect the annual headline U.S. CPI rate to fall to 4.97% for April and to as little as 2.4% by next February.Wednesday’s U.K. inflation report spurred big selling volume in Treasury futures overnight, and wasn’t entirely surprising considering this week’s “modest to low” economic data flows from the U.S., said Jim Vogel, executive vice president at FHN Financial in Memphis.“We’ve always been alert to EU [European Union] and U.K. inflation, but the story in the U.K. has been more volatile,” Vogel said via phone. “If the Bank of England thought inflation’s worst was done, and inflation surprises to the upside, why couldn’t it happen here? The idea that traders and markets could be surprised again by inflation in the U.S. got reactivated overnight.”The most recent U.S. consumer-price index report, released last week, showed the annual headline rate of inflation through March slowed to 5% from 6%, and touched the lowest level since May 2021. However, the narrower core reading which strips out food and energy, and which is seen as a more accurate predictor of inflation trends, climbed over the past 12 months to 5.6% from 5.5%. “There is always a risk that the market is underestimating the upside potential in inflation, and that’s particularly evident now in inflation surveys and TIPS prices which reflect a benign outcome,” said Mark Heppenstall, president and chief investment officer of Penn Mutual Asset Management in Horsham, Pennsylvania, which oversaw more than $31 billion in assets as of January.“Markets are generally expecting inflation to fade as economic growth slows,” he said via phone. “The consensus view is that recessions kill inflation, eventually. The key word is ‘eventually’ and it’s not clear how much damage needs to be done to the economy to get to the Fed’s 2% inflation target.”
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