These Eight Charts Explain What's Happening in Markets Right Now

From inflation, manufacturing, and bond markets to global trade, change is afoot for financial markets.

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It's back to school for financial markets. Bonds are out, stocks are in. Inflation in the developed world is on the prowl. Optimism for U.S. growth and corporate profits is sky-high. And President-elect Donald Trump casts a dark shadow over the outlook for global trade. 

In short, from inflation to manufacturing to bond yields to global trade, 2017 may herald a number of sea-changes for financial markets. Here are eight charts that paint the market landscape ahead.

Inflation breakout

One of the biggest themes for 2017 — the rising outlook for inflation — was underscored on Tuesday after German consumer prices staged a sharp 1.7 percent rise from a year ago, beating expectations of a 1.3 percent advance. Though underlying price pressures remain weak, the data may embolden European Central Bank hawks who argue the euro-area economy is on a firmer footing, justifying a shift away from loose monetary policies. Analysts at Societe Generale SA reckon ECB tapering fears are likely to haunt markets once more in the second half of the year. 

Commodity reflation

Headline inflation data in the euro-area and the U.S. in the coming months may be fueled by a pick-up in energy prices. West Texas Intermediate crude rose to $55 a barrel for the first time since July 2015, amid output cuts in Kuwait and Oman that suggest OPEC and its partners are going to deliver on an agreement forged last year to scale back production. 

Dollar devotion

Markets are also grappling with the prospects for the greenback after its Trump-fueled climb. The Bloomberg Dollar Spot Index, which tracks the currency against 10 of its peers, has notched a 6.5 percent gain since the Nov. 8 election, as expectations of looser regulations, higher government spending, and lower taxes bolster the outlook for U.S. growth and inflation.

The dollar rally raises a slew of questions for investors: Will the strength of the greenback pose a headwind for U.S. output in the second half of the year? Will it vex the Federal Reserve's monetary-tightening path? Given the dollar's role as the principal global funding currency, will its spirited strength crimp emerging market liquidity and growth?

Elephant in the room

China is one emerging market country that is reeling from the effects of a stronger dollar, which is serving to fuel capital outflows and tighten onshore domestic liquidity. To this end, China dropped a year-end surprise on sleepy currency markets, when it downgraded the relative importance of the dollar in its trade-weighted foreign-exchange basket, in an effort to better reflect the yuan's valuation against its trading partners. Though the move may have eased the risk of a one-off devaluation, yuan-depreciation expectations have surged year-on-year. 

All eyes are on China's foreign-exchange holding data, which will update with last month's figures on Jan. 7. If they drop below the psychologically-significant $3 trillion threshold, the currency would come under further pressure, complicating Beijing's bid to incent private investment and rein in credit growth.

Manufacturing cycle

An uptick in the global industrial production cycle may give Chinese policy makers some breathing space. On Tuesday, we learned U.K. manufacturing data for December advanced at its fastest pace in 30 months, helped by resilient demand and a weaker pound. In addition, Institute for Supply Management data showed that last month American manufacturing grew at its fastest pace in two years, underscoring soaring business confidence.

Euro-area manufacturing also grew in December, at its fastest pace since April 2011, feeding the market narrative that inflationary pressures are building up in the developed world, and that Corporate Europe is on a stronger footing. 

Analysts at JPMorgan Chase Bank say a pickup in business spending and goods price inflation will fuel an uptick in global manufacturing in 2017, with strong export data in Asia in November and December highlighting the growth in final-goods demand. 

Shifting yield curves

Another major theme this year is the outlook for term premiums — the extra compensation investors demand to hold longer-dated government bonds relative to shorter-dated obligations. In the U.S., U.K., and euro-area, they fell sharply in the middle of last year as markets bet that central banks would keep monetary policies loose.

According to analysts at Societe Generale SA, rising U.S. Treasury issuance and price pressures could fuel a notable rise in the term premium this year, as yield curves in the developed world remain flat relative to low absolute yields on short-dated obligations.

term premia
Societe Generale SA

The shape of the Treasury curve will heavily influence the capital-flow cycle in emerging markets this year, as much as the pace of Fed monetary tightening itself, if history is any guide.

Capex hopes

There is also a risk that markets have priced in too much good news too soon, if corporate earnings, other economic data, or fiscal policies disappoint expectations in the coming months.

One reason why analysts are bullish about U.S. output and stocks this year, despite the aforementioned headwinds, is the capital expenditure cycle. Analysts at Goldman Sachs Group Inc. say the great stagnation in inflation-adjusted U.S. business investment is set to draw to a close this year, thanks to the prospect that higher energy prices lift corporate profits and, therefore, lift capital spending.

Goldman Sachs Group Inc

According to AllianceBernstein Holding LP, a reduction in global capex last year crimped world GDP by one percentage point. The asset management firm says that pent-up capital spending may be ready to "break out" this year as corporate earnings improve, a boon for cyclical industries and infrastructure firms.

Political trumps

Financial markets threw caution to the wind last month, pricing in buoyant growth even as the specter of global trade wars looms large. Just two-and-a-half weeks before his inauguration, Trump tweeted another protectionist sideswipe at Beijing. 

Here's the projected impact on China's exports and GDP under different U.S. tariff levels, according to Daiwa Capital Markets. 

china tarriffs
Daiwa Capital Markets