By GILES COGHLAN
MAY’S inflation data surprised the financial markets. Initially predicted to fall to 8.4 percent, the figures came in far hotter than expected at 8.7 percent, while core inflation rose to 7.9 percent — well above the 6.8 percent expected, and the highest since 1992.
So the Bank of England (BoE) increased the base rate, for the 13th consecutive time, by 50bps. Again, a surprise for markets that had expected about 25bps — and a greater possibility of recession.
How should investors trade releases that deviate from expectations? In the currency markets, surprise economic data often lead to volatility. Last month, the pound initially rose, but later declined due to worries that the BoE may need to maintain higher interest rates for an extended period to control inflation.
Commodity markets also tend to fall if data deviate from expectations as investors anticipate a fall in demand for raw materials. Similar losses were felt by stocks — easily impacted by unexpected data, especially if those that directly impact a particular industry.
With London’s major indices suffering losses after the last release, homebuilders suffered the biggest declines on fears of an interest rate-related slowdown. But bond markets enjoyed a boost, as the data were unexpectedly high — increasing the likelihood of further rate hikes. Two-year bonds hit levels not seen since 2008.
How should investors trade such releases? One approach is to promptly enter the market after an unexpected announcement. This strategy is effective for significant market events, but it’s important to be cautious of buying at the peak of a sudden surge. Investors should exercise caution when entering the market and establish a well-defined exit plan.
Cautious investors may choose to enter the market at a retracement, waiting for a temporary pullback or price correction once the initial market reaction has died down. This allows them to enter at a more favourable point, minimising the risk of entering at a temporary spike. There is a possibility that the price may not retrace, leaving investors in the lurch…
Investors who prefer to anticipate a data release can enter the market before the information becomes public, aiming to profit from the initial market response. Those who correctly predicted higher-than-expected inflation last month could have taken advantage of the short-lived GBP rally immediately following the announcement of the Consumer Price Index (CPI). It’s worth noting that such an approach carries speculative risk, so carry out due diligence before making decisions.
Surprise economic data can create volatility that investors can capitalise on — but they must have a clear plan that matches their individual circumstances to mitigate risk.