Here's a simple explanation for why markets are freaking out

The simplest explanation for the sell-off in US stocks on Friday — the Dow fell 2.5%, or 666 points, its biggest points fall since 2008 — is that investors are worried the inflation genie might be out of the bottle.

The searing run of US job creation finally has America’s labour market at a point where wages are starting to rise more rapidly than anticipated.

After the release of the US monthly jobs data on Friday, which showed wages growth rising at 2.9%, Deutsche Bank’s chief international economist Torsten Slok released a presentation on Friday which was ominously titled: “US employment outlook: Labour market beginning to overheat.”

Here’s the first chart from that deck, showing wages are finally showing a consistent surge in growth.

Deutsche Bank

The jobs data triggered a sell-off in bonds. In Australia, coverage of financial markets tends to skip over developments in fixed income, but seasoned investors and traders know that trouble always starts in bonds.

Here’s a chart of the global benchmark US 10-year Treasury yield, going back all the way to 1990. It shows the price of bonds — which falls as yields rise — has been getting thumped, decisively breaking a decades-long trend.

Credit Suisse

Chris Weston, IG Markets chief markets strategist, wrote in a weekend note: “It certainly feels as though something changed last week, something fairly significant and where for so long markets lacked any sign of a pulse, the idea that we are now facing a period of elevated implied volatility has knocked us all a bit for six.”

The concern among investors is that the US Federal Reserve will need to increase rates a little more quickly than anticipated, raising borrowing costs which could slow economic and earnings growth.

Australia is not without exposure. A world of rising borrowing costs could also have an impact here as the price of funding for banks increases and the cost being passed on to households and businesses.

“So a new chapter is upon us and the markets are already speaking out,” Weston added, “and it feels that given the moves in the long-end of the US bond market, as well many other developed markets… that world that has finally bought into the notion that inflation is coming.”

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