Markets start the week contemplating the Fed "running hot" strategy

Fed Chair Yellen’s speech on Friday has seen Australian bond yields jump this morning as markets react to the possibility that the Fed might join the Bank of Japan in conducting policy to steepen the yield curve. This “running hot” scenario would be a positive environment for profit growth and should suit cyclical sectors like industrials and materials stocks.

Fed Chair Yellen’s speech on Friday has seen Australian bond yields jump this morning as markets react to the possibility that the Fed might join the Bank of Japan in conducting policy to steepen the yield curve. In the Fed’s case, this might amount to running the gauntlet of higher inflation with a very slow pace of monetary tightening. This would see the economy “run hot” with higher growth and inflation rates than currently anticipated. In this scenario long bond yields would rise while short term rates would be relatively subdued.

This “running hot” scenario would be a positive environment for profit growth and should suit cyclical sectors like industrials and materials stocks. Relatively speaking, however, “yield” stocks may under perform as higher bond yields act to reduce their attractiveness.

Even so, Friday night’s economic data supports the possibility that the Fed will make its next move in December. News that China recorded its first positive read in producer price inflation for some years is a positive for global inflation.  The solid rebound in US retail sales in September helps allay concerns about the weak performance of the previous two months.

The stock market is likely to start the week with a relatively subdued opening. Share investors may be cautious until they assess whether this morning’s bond market weakness will continue. Although iron ore prices rose again on Friday, other key commodities like copper and oil softened, suggesting a cautious approach for the resources sector in early trade.