Stagflation fears keep equity markets in a sombre mood

[October 04, 2021]    By Sujata Rao

LONDON (Reuters) -World stocks were on the back foot on Monday and the dollar stayed close to one-year highs on concerns that higher inflation, supply shortages and China's property sector woes would put global economic recovery at risk.

Stock markets slipped to 2-1/2-month lows last week, following a torrid September that saw them shed more than 4% as U.S. Treasury yields surged 20 basis points, the Federal Reserve signalled its readiness to start unwinding stimulus this year and Chinese property giant Evergrande headed for default.

Those factors remain in play, with trading in Evergrande shares suspended, days after it missed a second set of interest payments on offshore debt.

Wall Street was set to open weaker, with focus on the fate of the Biden administration's multi-trillion dollar spending plans, Congressional wrangling over the Treasury debt ceiling and Friday's monthly jobs data that may allow the Federal Reserve to proceed with tapering its bond-buying.

Futures for the S&P 500 and Nasdaq indexes were down 0.4%, while Dow Jones e-minis slipped 0.3%.

A pan-European equity index that lost 2.2% last week seesawed around flat, while Asian shares earlier weakened, led by a 2.7% loss in Hong Kong and a 1% fall in Japan's Nikkei.

Francois Savary, CIO of Swiss wealth manager Prime Partners, said markets were increasingly pricing a stagflation scenario of lacklustre growth and high inflation, a headwind for stocks which have scaled a series of record highs and trade at expensive multiples.

"You can live with highly valued markets if you have the prospect of economic growth ahead. But if you think stagflation is becoming an issue and the only option is to tighten policy and kill economic activity, that's not good for equities," Savary said.

While recent data showed robust U.S. consumer spending and factory activity, inflation fears are being fanned by crude futures near three-year highs of almost $80 a barrel and European gas prices approaching a record 100 euros per megawatt hour.

That, alongside persistent supply glitches, could force central banks to tighten policy sooner than expected.

Already, the core U.S. PCE price index, the Fed's preferred inflation measure, increased 3.6% in August from a year earlier, its biggest rise in three decades, while euro zone inflation hit 13-year highs.

While Fed boss Jerome Powell and other policymakers insist high inflation is transitory, Norihiro Fujito, chief investment strategist at Mitsubishi UFJ Morgan Stanley Securities, noted "Powell also recently starting to hedge his comments too, leading investors to suspect he, too, is worried about inflation".

Adding to the growth worries, investor morale in the euro zone fell for the third month in a row in October.

OIL AND DOLLAR

There may be little relief on the oil front as the OPEC plus group of producers will likely stick to existing agreements to produce an additional 400,000 barrels per day (bpd) in November, rather than adding output, Reuters reported.

Investors are looking ahead to Friday's monthly U.S. payrolls data, forecast by a Reuters poll to show 500,000 jobs added last month.

"All roads this week point to payrolls Friday, as unless there is a marked deterioration across the whole sweep of labour market indicators within the report, this will likely be the catalyst to cement the November taper," Deutsche Bank wrote.

Those concerns have lifted the dollar near one-year highs against a basket of currencies and put it on track for its biggest annual rise since 2015.

The greenback eased slightly on Monday, allowing the euro to bounce to $1.16270, off Thursday's 14-month low of $1.1563. It also dipped to 111.270 yen, staying below Thursday's 1-1/2-year high of 112.08 yen.

"If you believe stagflation is coming, you want to get out of cyclical stocks and go into safe-havens like the dollar," said Savary at Prime Partners.

U.S. bond yields inched higher, but 10-year yields at 1.49% stayed off Tuesday's three-month high of 1.567%.

The offshore-trade yuan, meanwhile, fell a quarter percent at 6.4502 as investors weighed the Evergrande impact. They also awaited a speech by U.S. Trade Representative Katherine Tai on the Biden administration's strategy for U.S.-China trade ties.

(Additional reporting by Hideyuki Sano in Tokyo; Editing by William Maclean and Alex Richardson)

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