Thursday Outlook: Bernanke, Trichet Speak as Markets Sniff Out Inflation

Like a warning curl of smoke, inflation talk is working its way through financial markets.

Jean-Claude Trichet
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Jean-Claude Trichet

Therefore, the timing is good for markets to hear Thursday from both Fed Chairman Ben Bernanke, who sees no inflation threat, and European Central Bank president Jean Claude Trichet, who's been seeing signs of it in the euro zone. Trichet speaks before the U.S. market open, at the close of the ECB's rate meeting. Bernanke speaks at a 12:30 p.m. luncheon at the National Press Club, after which he will take questions.

"The ECB is at the top of my list," said Brian Dolan of Forex.com. "Is Trichet going to be taking the hawkish stance he took at the last meeting, or is he going to dial it back?" Trichet's initial comments about inflation last month helped send the euro higher against the dollar on the expectations the ECB would be first to move rates higher. The euro is now up 3 percent year-to-date.

Inflation has been a problem for the developing world, as commodities prices soar, and like China, countries have been tightening in response. In the U.S., the Fed still sees a lack of inflation, but Bernanke has said there is now less chance for deflation, since the Fed began its latest "quantitative easing" program in November.

Just on Wednesday, copper hit another fresh high. Wheat futures rose 3.3 percent to a 2-1/2 year high, and sugar climbed to a more than 30-year high as Cyclone Yasi hit Australia. In the stock market, companies increasingly are talking about raising prices to offset rising costs. Whirlpool and AMR are two recent examples, but some, like Hershey, in its earnings release Wednesday, acknowledge rising commodities prices but say other cost reductions have been made.

PNC's Bill Stone sent out a note Wednesday on how to protect your portfolio from inflation, though he doesn't see a particular threat now. His report noted that gold, commodities and Treasury Inflation-Protected Securities are all good hedges.

"We are seeing the headline inflation come through, but our view is it's going to stay contained...It's hard to see a widespread inflation problem when you don't have pricing power on wages," said Stone, chief investment strategist at PNC Wealth Management. Many economists, and the Fed, believe there is still enough slack in the U.S. economy to prevent inflation from taking hold in the near future and unlike in the emerging world, rising grains prices have just a small impact on U.S. food prices.

"We're keeping a close eye on it (inflation). We just don't think it's there yet. it's moving form what was a cold stew to a luke warm stew," Stone said.

Stone said he found that stocks perform better than bonds and cash during inflationary periods. "Stocks are probably not going to like inflation over some short time frame. Obviously, they didn't have a problem coming from disinflation to some amount of inflation. At some point, they would have some short-term headwinds. The thing we do know over history is that corporates do adapt to inflation," he said. Earnings ultimately rise with inflation and offset some of the negative impact of inflation.

Egypt Jitters

The dollar firmed slightly Wednesday, as did oil as protesters clashed with pro-Mubarak supporters in the streets of Cairo. Oil rose $0.09 to $90.86 per barrel. The dollar rose 0.2 percent against the euro and about the same against the yen. The euro was at 1.3810 at the end of the day.

Stocks held in a narrow band Wednesday, with the Dow ending the day up just 1 point at 12,041, and the S&P 500 slipped 4 points to 1304. Airline stocks were poor performers as the industry cancelled more than 6,300 flights Wednesday, in a second day of mass cancellations, because of the massive winter storms crossing the U.S. The Dow Jones Transport index was down nearly 2 percent.

Bond Yields Rising

Treasury yields ran up Wednesday, sparking debate in the bond market about whether higher those yields reflect stronger U.S. economic data or rising inflation concerns.

"Everyone's asking the magic question today. I think there's a lot of concerns about inflation around the world. In the U.S., we've had a lot of intraday volatility. We haven't had that much volatility this year. This is the highest yield we have seen in 2011. Yesterday, we were trading in the 3.30s," said Brian Edmonds, who heads Treasury trading at Cantor Fitzgerald. Edmonds also said mortgage-related selling was a factor.

Yields Climb

The 10-year yield touched 3.5 percent, but finished the day at 3.491 percent. The 30-year was a better performer on the day and was yielding 4.619 percent, but it hit a 9-month high of 4.62 percent.

BNP Paribas' Rick Klingman is in the camp that believes Treasurys are moving on the stronger U.S. data. "The 30-year would be the worst on the day if that were the case," he said of the inflation talk. "We're still in the range and we're trying to break out. If you get a good payroll number Friday, we'll break out of this range and get higher yields."

On Thursday, markets will be watching the 10 a.m. ISM nonmanufacturing report, after the January ISM manufacturing data came in exceptionally strong on Tuesday. The manufacturing report also showed a big jump in prices paid.

There are also weekly jobless claims and productivity and costs data, at 8:30 a.m. Factory orders are reported at 10 a.m., and chain stores report monthly sales during the day.

Earnings Central

Thursday's earnings reports include Deutsche Bank, GlaxoSmithKline, Merck, Sony, Unilever, Blackstone Group, Viacom, CME Group, MasterCard, Moody's, Diamond Offshore, CVS Caremark, International Paper, Kellogg, Estee Lauder, Starwood, New York Times and AMB Property. Coinstar, Las Vegas Sands, Sunoco and JDS Uniphase report after the closing bell.


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