FTSE 100 Stuck Below 6,800 as Investors Monitor Inflation
Key Talking Points:
- The FTSE hits resistance at 6,800 after a strong rally brought on by rising energy prices
- UK CPI rises more than expected in January as household spending increases
- Rising bond yields pose a threat to equities
The FTSE 100 has managed to break free from the center point of its previous range and is now sitting just below the 6,800 mark as bond yields continue to rise rapidly as the economy remains well supported in the short-term with regards to monetary stimulus. Yields on US treasuries have risen to almost pre-pandemic levels as the nation of economic recovery is gathering steam, leading to an increase in risk appetite in the short-term.
Warning signs continue to show in equity markets and the rapid rise in bond yields gives reason for concern about an overheating economy, despite the Federal Reserve’s attempt to calm the nerves regarding possible future monetary policy changes. I do expect stocks to cool-off in the short-term but the longer outlook continues to be positive.
The FTSE 100 is showing signs of exhaustion around the 6,800 mark, which is the upper bound of the Bollinger bands, and the stochastic oscillator is showing clear signs of a small price reversal in sight. Short-term support can be expected around the 6,600 mark, where the 50-day moving average is currently residing, followed by the 61.8% Fibonacci (6,489) where price had previously been consolidating. Any further bearish momentum may see the UK stock index break below 6,400, heading for strong horizontal support at 6,355.
Alternatively, given how equities have been resilient to bearish pressure, a sustained break above 6,800 would encourage buyers to strengthen their position, attempting to break the 11-month high above the 76.4% Fibonacci (6,894) at 6,957.
FTSE 100 Daily chart
UK INFLATION HIGHER THAN EXPECTED
British inflation edged up in January as lockdown saw consumers spend more on food and consumer goods. The reading was 0.1% higher than the 0.6% expected by analysts ad this tendency is expected to continue in the coming months, as tax cuts come to an end and rising oil prices on the back of a better economic outlook, falling closer in line with the Bank of England’s (BoE) target rate of 2%.
UK bonds have been following the trend in the United States and have seen their yields increase significantly in the last few weeks, but the BoE has already reassured consumers that it is in no hurry to increase rates and remove current stimulus, even as inflation expectations increase with the successful rollout of vaccines.
UNITED KINGDOM CPI
BOND YIELDS ON THE RISE
There is generally an inverse relationship between bond yields and equities, given that they represent the opportunity cost of investing in stocks, which means that a stock has to offer a return at least as high as the yield on bonds to make it an attractive investment. As bond yields go up, equities become less attractive because the higher return from taking on additional risk is diminished.
Whilst this relationship may take some time to materialize given the current recovery from the pandemic lows, rising bond yields pose a threat to stocks once the euphoria of an economic recovery settles.
Chart: US 10 year yield vs S&P 500
For now, stocks seem to be focused on improved economic data and the possibility of a return to normal this summer as the rate of vaccinations picks up worldwide, leaving a short-term positive correlation between yields and stocks, but investors need to be aware of any sign of inflection on equity prices as a downside correction is bound to happen at some point.
--- Written by Daniela Sabin Hathorn, Market Analyst
Follow Daniela on Twitter @HathornSabin
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