Author|Dai Xianfeng
Overseas macro hedge fund manager, communication planet APP expert (TA has settled in communication planet APP)
PS: The views in this article are for readers' reference only and do not constitute personal investment advice, and investors should judge and bear their own risks based on their own circumstances.
A. Summary
Risk assets have been sold off as markets have repriced Fed easing expectations since April. Some even expect the Fed to raise interest rates. This is because inflation data for January, February, and March were all higher than expected.
On Thursday and Friday, the market rebounded after Powell's dovish comments and good jobs data.
However, the April inflation data, which will be released on May 15, may be too high or normal. It is possible that it will return to the downward trend of inflation, as I expected/hoped. But it is also possible that it will be higher than expected. This is a known unknown.
There is a reason for the expectation that inflation will fall back in April. The seasonal/lagging factors that drove higher-than-expected inflation in the first quarter are likely to disappear, while the factors driving inflation down are still there. Commodity price inflation is likely to continue to fall as the supply chain strains caused by the pandemic are long gone. It is difficult for oil prices to rise sharply, and it is even possible that they will fall. The job market is slowing.
But inflation in April could still be surprisingly upside. This is because the data from month to month is highly unpredictable.
If the current market rally is sustained solely because of Powell's speech and job market data, it may be wise to hedge against inflation risks in April at a later date.
That's because the market's reaction to inflation in April is likely to be asymmetrical – the damage from a surprise rise could outweigh the benefits of meeting expectations.
If there is an unexpected rise in inflation in April, the market and the Fed may interpret it as a trend is forming. Expectations of declining inflation and the associated market pricing are likely to disappear and the market is likely to sell. Powell may find it difficult to downplay inflation data again, and the Fed may be forced to make a clearer statement that it wants to fight inflation, not just contour rates play a role in the economy over time. The Fed may give a hint that the market may price in the possibility of a rate hike. Volatility will be high.
If April's inflation returns to a downward trend in inflation, the market is likely to rebound. However, the rally is likely to be more modest, as it is basically a relieving rally that has already begun. But the rebound from falling inflation is likely to last longer, as the downward trend in inflation revalidates and inflation data in the coming months is likely to continue to confirm this. In this case, investors have time to catch up even if they miss the day's rally.
Therefore, hedging April inflation risk may be a smart strategy for volatility-sensitive investors/traders.
B. The market is selling off due to inflation
Markets sold off on higher-than-expected inflation data for Q1.
Inflation data pushed Treasury yields higher.
As yields continue to rise, stocks start to fall. The S&P index has been falling since the 10-year Treasury yield reached 4.2% in April.
C. The market rebounded on the back of Powell's comments and employment data
Powell's comments eliminated the possibility of a rate hike. The market rebounded.
This was followed by good employment data on Friday. Nonfarm payrolls rose by 175,000 in April, well below the 200,000 average since 2023. The unemployment rate rose to 3.9%, 10 basis points higher than expected. The market rebounded further.
D. Hedging April inflation risk
Long-term investors don't need to hedge against inflation risk for a month, especially if they recognize the downward trend in inflation.
Volatility sensitive investors may consider hedging April inflation risk as the market's reaction may be asymmetrical. If the inflation data meets expectations, they can close their hedged positions.
If the market continues to rally just because of Powell and the job market data, then the case for hedging is even stronger.