Fed faces crucial test as US inflation accelerates and bond yields rise: Jefferies

In its latest GREED & FEAR note titled "Bond pressures and AI resets", Jefferies said that financial markets are entering a challenging phase following the latest US inflation data.

The report noted that "Financial markets remain set up for a test of the new Federal Reserve chairman following the release of the latest CPI data."

Headline CPI inflation in the US increased from 3.8 per cent year-on-year in April to 4.2 per cent in May, while core CPI inflation rose from 2.8 per cent to 2.9 per cent. Energy prices were a major contributor, with Energy CPI surged by 23.5% YoY in May, the highest level since August 2022.

Jefferies highlighted that inflationary pressures are being exacerbated by geopolitical developments. The report said, "While it is true that AI should turn out to be disinflationary, it will surely be hard for Kevin Warsh to look completely through the rising price pressures stemming from tariffs and, more importantly, the Iran conflict, most particularly as the Strait of Hormuz remains closed."

The brokerage pointed out that producer price inflation has also remained elevated, noting that "PPI ... rose by 6.5% YoY in May compared with consensus estimates of 6.4%."

Jefferies warned that bond market movements could become a crucial indicator for investors. It stated that "GREED & fear continues to view the 10-year Treasury bond yield as the most important price in world markets."

The report observed that the 10-year Treasury yield has climbed from a recent low of 3.92 per cent in early March to 4.52 per cent. Jefferies notes, "A clear break above the 4.5% level should be viewed by equity investors as a warning signal," while "a more decisive move above 5% would be more like a red traffic light."

The brokerage also flagged growing concerns around the US fiscal position. It said that higher Treasury yields may initially support the dollar, but "sooner rather than later higher yields will become dollar bearish because markets will refocus on America's fiscal position which in turn will lead to renewed focus on the US dollar debasement trade."

On gold, Jefferies maintained a constructive medium-term view despite near-term risks from rising yields and tighter monetary expectations. The report said gold remains vulnerable in the short term but added that investors should consider increasing exposure to gold-related stocks if prices move towards the lower end of the current trading range.

The report notes that inflation dynamics, Treasury yields, fiscal concerns and the sustainability of the AI-led investment boom will remain key themes shaping global financial markets in the coming months. (ANI)