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  • Online retailers fall on sales tax report
  • Inflation in focus as yields climb
  • EURUSD outside candle

Shares in online retailers Asos, Boohoo Group and Ocado fell on reports the UK government is mulling a tax raid on companies that have profited from the pandemic. This may raise a question about opportunistic tax policy (the government is meant to be pro-business), however most people feel online retailers are not paying their fair share and the burden is falling too much on struggling high street stores. It’s never made sense that bricks-and-mortar businesses pay more in tax than the very rivals who are stripping away their market share. A possible tax hike aimed squarely at online sales presents a near-term overhang for these stocks, but they remain structurally well positioned to capture more sales as consumer habits continue to shift online. Boohoo and Asos both fell over 3% in early trade, whilst Ocado was down less at –1%. The news comes as Boohoo buys Dorothy Perkins, Wallis and Burton for £25.2m from Arcadia, following Asos snapping up Topshop etc last week. Boohoo’s purchase exposes the brand to a much broader consumer base but the online sales tax raid has somewhat overshadowed the move.

European stock markets were broadly higher at the open, extending a good run last week, whilst US futures are pointing higher today after hitting fresh record highs on Friday. The risk-on mood seems to be driven by a combination of falling case numbers in developed countries, whilst efforts by Congressional Democrats to pass Joe Biden’s $1.9tn stimulus without Republican support has delivered a fresh shot of confidence into equity markets. Vaccine setbacks – the AstraZeneca version is not so effective against the South African strain – are being largely shrugged off as cases fall. The risk-on mood is evident with Asian shares broadly higher, Brent crude taking a $60 handle and US 10-year yields are at a one-year high close to 1.2%.

Indeed, as long-end yields rise and curves steepen, inflation is shaping up to be the real test of market strength this year. Inflation is the big unknown as we don’t really know how central banks will respond – in fact I’m not sure if they know since none of the current crop of central bankers have the experience of needing to tame an inflation tiger. They are programmed to cut and ease, and tapering bond purchases has been as much as can be countenanced. The Fed did raises rates in the Trump period as the economy took off, but it was not due to rising inflation, simply to put the brakes on growth, prevent overheating and find some ammo for the next downturn.

Things have changed since then. Not least, the Fed will no longer act preemptively to cool the economy based on models of unemployment, wage growth and the Philips Curve. Instead, average inflation targeting explicitly calls for the Fed to stand pat even as inflation exceeds its 2% target. It will wait until the economy and jobs market are swinging again before hiking. Except, if inflation starts to shoot higher – and I think we have a perfect cocktail of demand and supply side forces to create inflation this year – then the Fed may need to act. Not just the Fed – the Bank of England last week said spare capacity in the economy will be eliminated this year.  I’ve consistently stressed that while the pandemic was initially deflationary, it would lead to inflation at the kind of levels that worry policymakers.

On inflation you have several forces at work. Supply side or ‘cost push’ – commodities are rising in price, supply chains are becoming more expensive and the recent manufacturing PMIs point to rising input prices. In fact, as detailed here last week, the last IHS Markit US manufacturing PMI reported that cost pressures worsened amid raw material shortages, and firms passed this on as selling prices rose at the fastest pace since July 2008. The ISM PMI noted inflationary pressures, too, as the Prices Index surged to 10-year high last month. On the demand side, higher costs are easily passed on as the fiscal and monetary stimulus has injected vast amounts of new money into the system and liquidity remains ample. US five-year breakeven inflation rates are at their highest in 8 years, whilst the 5s30s curve is at its steepest since 2015. 2s10s is at 1.10%, the steepest in almost 4 years.

All this matters in the end since if the US 10-year (risk-free) rate hits say 1.75%, it starts to lower the appeal of equities at current valuations. Tina – there is no alternative – starts to look less appealing. Bank of America says that while more than 60% of S&P 500 companies currently yield more than the 10-year does, should it hit 1.75% this percentage drops to 44%. Corporate debt markets are also at risk of a shakedown should Treasury rates move up.

In FX, the US dollar suffered a big reversal on Friday and backs my belief that the recent move higher was a bull trap. Sterling recovered $1.37 and a fresh stab at the 33-month high at 1.3760 looks to be in sight. This level held several times in late January and will a breach could see momentum follow through strongly to 1.40. Note on Friday’s outside candle on EURUSD, a possible bullish engulfing reversal as the trend support has been recovered.

Possible bullish engulfing reversal as the trend support has been recovered on EURUSD.

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