January 9, 2017

Stocks opened higher again this morning (Dow +99 pts; SPX +.3%). Healthcare stocks are on the rebound after yesterday’s rout. In fact, the Nasdaq Biotech Index is up 1.6% at the moment. Banks are also rallying over 1%. Bond replacement stocks, such as utilities, telecoms and real estate are down. The dollar is stronger against a basket of foreign currencies and bonds are selling off. The 5-year Treasury yield shot up to 2.31%, which is a long-term resistance level going back to April 2011. The 10-year yield is also moving higher, to 2.53% (highest since last March). The next level of resistance is 2.63%. If Friday’s CPI inflation report comes in high, the 10-year could possibly hit that resistance level in short order.

The yield curve is (thankfully) steepening a bit today. The difference between the 2-year and 10-year yields is back up to 57 basis points after having recently fallen to a mere 50 basis points. Last weekend’s Barron’s magazine ran an article about inflation expectations for 2018. The Federal Reserve currently expects its preferred inflation gauge (“Core PCE”) to rise from 1.5% to 1.7% by the end of this year. Other gauges like the Consumer Price Index (CPI) that include food & energy are predicted to be higher, around 2.2%. And then there’s the New York Fed’s new Underlying Inflation Gauge (UIG), which attempts to cast a wider net to discover true inflation in the economy. UIG has been moving steadily upward since the end of 2015 and suggests inflation is closer to 3%. Anyway, despite admitting that inflation trends are very hard to predict, the  article posits an inflation scare this year and says the best way to deal with it is to invest in financials, materials, and energy. 

Bloomberg says the immediate cause of higher bonds yields—around the world, by the way—is a surprise but temporary pause in bond-buying by the Bank of Japan. In addition, investors are looking at new issue schedules around the world and seeing a lot of new bond supply from governments in the US, UK, Germany and Japan. Higher supply of any security usually hurts its price. 

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