Stocks and bonds fall again amid mixed inflation reports

Stocks and bonds continued their sell-off yesterday.

The day had started off rather badly, with China reporting that inflation rose to 3.4 percent in May from 3 percent in April. That caused the Shanghai stock market to fall more than 2 percent at one point, although it subsequently recovered.

The inflation news yesterday was better in Europe. In the UK, the inflation rate slowed to 2.5 percent in May from 2.8 percent in April, while in Sweden, the inflation rate slowed to 1.7 percent in May from 1.9 percent in April.

There was no inflation news from the US. The PPI report will be released tomorrow while the CPI report will be released on Friday. But there was a lot of discussion nevertheless on the US bond market.

Mike Larson reminds us that if the US yield curve were to normalise, the yield on the 10-year Treasury could rise to 5.82 percent.

Perhaps that is what is needed to curb inflation in the US. Macro Man says that with the rising trend in food and energy prices, the core prices that the Fed is focused on understates the actual rise in the cost of living, and "even a return to the 1.75% core PCE target would imply a trend headline CPI rate of 2.8%-2.9%".

Incidentally, a 2.8-percent inflation rate is what the Cleveland Fed's 16% trimmed-mean CPI has been showing for February, March and April. And as I mentioned in "US inflation falls but hold the celebrations", I think the trimmed-mean CPI is a better measure of underlying inflation.

So inflation is a good reason for the bond market to push yields up, but Brad Setser thinks that a move by Asian central banks towards the short end of the curve could also have played a part. And with both China and Japan continuing to report rising trade surpluses, Asian central banks are likely to continue to play important roles in the bond markets.