Inflation, Bond Market and Trajectory of Stock Market amidst Lockdown Fears

Fearing that the increase in Covid cases will slow global economic growth, stock prices fell sharply as the week commenced. Sales rebounded during Monday afternoon, and the Dow Jones Industrial Average was close to its biggest decline of the year. The Dow Jones Index fell 920 points which is 2.7%, before surpassing a 2% drop in January. The S&P 500 index dropped 2.1%, with the sectors such as energy and industry performing the worst. The Nasdaq Composite that is dominated by technology companies, lost 1.5%. The Russell 2000 Index briefly fell into the correction zone, down 10.7% from the 52-week high. The 10-year Treasury bond yield fell 1.19% which is a new five-month low, adding to concerns about slowing economic growth. Oil prices too witnessed a drop of more than 6%.

Additionally, another aspect of the economy that has got everyone worried is inflation and the Fed’s policies with respect to it. When we look at inflation we’ve seen a rollover of a number of materials from lumber to gold and now oil too.

If core inflation levels are taken and lumber, energy, or other commodities are taken out inflation will remain as high as the overall headline rates. The reopening trades like airline tickets and used car prices will come down but shelter inflation is going up. So inflation is probably going to stay and thus bond market should not ignore it since it’s all about growth. A look at a ratio of the growth stocks shows that the reopening stocks to the S&P track interest rates. The reopening stocks have been struggling for the last couple of months and rates have been falling. So this is all about a fear that the economy is going to slow. It is a fear that the delta variant is going to lead to more lockdowns and that is what has got everybody worried.

The real question that investors need to grapple with is whether they think more lockdowns are coming or not. With each successive wave, there has been less and less of a response. New York City said it is not going back to indoor mandates. Public schools have refused to shut down for the third year because they’ve seen kids dropping out of the public school system. Some analysts are of the opinion that any kind of shutdown risk is way lower now than it was in the past. Los Angeles did go back to masks and case counts while low have been doubling every seven days. If that keeps up for another two or three weeks then there might be a very different narrative by the end of the month when it comes to shutdowns.

Right now the market is worried that growth is stalling badly. Investors and traders are worried that the delta variant is going to lead to some kind of restriction in economic activity.