Yesterday came the moment markets had been holding their breath for all week US inflation data.
In theory, a lower-than-expected figure would have been good. With rising bond yields copping the blame for the recent spasm in stock markets, any more signs of pressure on prices would in theory have hurt stock markets.
The number came out higher than expected. Cue a rapid sell-off in everything.
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And then unexpectedly a solid rebound. The S&P 500 finished the day up 1.3%, after first falling 0.5% in reaction to the data.
So what gives?
US inflation is stronger than anyone expected
US consumer prices are rising at a rate of 2.1% a year. That was stronger than the 1.9% expected. Meanwhile, core inflation came in at 1.8%, whereas it was expected to fall to 1.7%.
Rising oil prices (and therefore petrol prices) affected the headline figure (American drivers are far less taxed than most, so rising oil prices feed into petrol prices far more visibly than in the UK).
The higher-than-expected inflation figure had the expected impact on Treasury yields. They shot up and this morning they've stayed there they're now above 2.9% and really not far from the 3% which is now viewed as the next big "line in the sand".
And at first, the figure also knocked markets back. First, there's the fear element "rising bond yields caused the Vix explosion last week, so this must be bad."
Secondly, there's a logic to it "rising inflation means the Federal Reserve will raise rates more quickly, so the dollar should rise, stocks should fall, and precious metals should fall too".
And all of that happened. At first. And then it reversed. In fact, gold exploded higher later in the day, having one of its best trading days since 2016.
Why?
What really matters to stocks and gold real interest rates
What investors are perhaps starting to wake up to is this: the inflation data definitely matters in the near-term for US bond markets. Inflation is entirely toxic for bonds. You have a fixed cash flow higher inflation means that cash flow is worth less.
But as far as stock markets go (at this stage) and as far as gold goes, it's not so much inflation as the Federal Reserve's reaction to it that's important.
Stocks don't like higher inflation, but they can tolerate it to a point. Once we get to more chaotic, rapid inflation (and it doesn't take long to get there 4% or so is definitely pushing the comfort zone), then stocks start to wilt.
But in the meantime, if higher inflation comes from stronger growth, then technically speaking, companies should be able to raise prices to go along with it. So they can weather inflation better than bonds.
So if the Fed just shrugs its shoulders, then real interest rates will in fact fall as inflation rises (because rate rises if there are any lag behind rising inflation). So stocks don't have to worry about tighter monetary policy right away.
And nor, importantly, does gold. Falling real rates are good for gold. So what the surge in the gold price suggests to me, at least is that markets suspect that inflation will sprint ahead of the Fed's desire to contain it.
That makes sense.
Throughout the whole of the financial crisis and its aftermath, the Fed talked about allowing the economy to "run hot". And various Fed decision makers have nodded to the idea of raising the inflation target.
Is it really going to switch philosophy now, just because it has a new boss?
Remember - the Fed responds to the clearest, most present danger at any point. Sure, it talks about monetary policy operating with a "lag" and it does plenty of economic forecasts. But everyone knows that these really aren't worth the paper they're printed on. At best, a forecast gives you a baseline to work from, for figuring out all of the ways you could potentially be wrong.
We talk in awed tones about Paul Volcker breaking the back of inflation, like he was the only honest, sound money man to ever sit in the Fed chair. But a more honest interpretation is that Volcker had no choice. When inflation is heading for 20% a year, that's the threat you have to tackle. Your choice might be unpopular, but it's not hard to make.
That's not the environment we're in now. A specific theory about the Great Depression that it was the Fed's fault for tightening monetary policy too quickly has formed the backbone of the response to the Great Recession of 2008.
I don't expect that to change now.
As I've been saying for a while, the next crisis will be inflation driven. We've not seen that for a long time. And it means that we may well get that melt-up everyone's been on about, before the current bull market is done.
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