Following a very strong year in 2021, the new year commenced on a negative note as markets were spooked by the prospect of higher inflation. As mentioned in previous reports, there is no greater economic evil than inflation which has a damaging effect on financial markets. Despite a rally late in the month, equity markets around the world were sharply lower in January with the broader US market falling by 5.9%, while technology stocks fared even worse falling 9.5% in response to higher discount rates being applied to long term earnings because of rising bond yields. The Australian market fell by 7.4% and most Asian markets recorded similar declines with Japan down 6.4% and China 6.6% lower.
Bond yields are very sensitive to inflation expectations so understandably they moved higher with Australian 10-year bond yields up 11 bp to 1.9% and US Treasuries up 14 bp to finish at 1.8%. There were significant moves in commodities as well, especially in the energy sector where crude oil was up 16% and natural gas up 29%, also contributing to the higher inflation outcomes. The strong demand for lithium for electric vehicle batteries saw the metal rise 36% for the month and a staggering 504% higher over the past year.
The prospect of a widening interest rate differential with the US, saw the AUD fall close to 3% to finish at USD 70.6.