Global stocks and government bond markets consolidated on Monday following tumultuous moves in response to the US central bank taking a hawkish shift on interest rates and inflation.
The FTSE World index of global shares, which lost 1.9 per cent on Friday, declined 0.3 per cent while a rally in US Treasury bonds also eased. The Stoxx Europe 600 index traded flat.
Monday’s moves followed the worst week for Wall Street’s S&P 500 stock benchmark in almost four months. The sell-off was prompted by comments from Federal Reserve chair Jay Powell on Wednesday that signalled the central bank could raise rates to tame inflation sooner than investors had expected.
The change in stance by the Fed prompted investors to back out of “reflation” trades, which had involved selling government bonds and buying up shares in companies whose fortunes were pegged to economic growth, such as materials producers and banks.
The yield on the benchmark 10-year US Treasury bond, which moves inversely to its price, declined 0.02 percentage points to 1.433 per cent in early European trading. This yield had dropped sharply from close to 1.6 per cent before the Fed’s meeting last Wednesday.
The yield on the 30-year Treasury briefly fell below 2 per cent on Monday for the first time since February 2020, before bouncing back to 2.034 per cent.
The Treasury rally has confounded some investors. Powell last week said that the US central bank would move to discuss reducing the $120bn of monthly debt purchases it had conducted since last March. Fed officials issued new projections for two interest rate rises in 2023 while one, James Bullard, suggested on Friday that the US could raise rates as early as late 2022.
Strategists at Credit Suisse explained that traders were buying bonds as they now viewed the Fed as more willing to control future surges in inflation, which lowers the real returns from fixed interest securities.
The 10-year break-even rate, a market measure of anticipated inflation in the world’s largest economy, hit its lowest point since early March on Monday morning.
“The hawkish shift in the Fed’s rhetoric has depressed the market’s inflation expectations,” said strategists at Credit Suisse.
Investors had been “clearing out positions” on earlier reflation trades that had become crowded and “expensive”, said Salman Baig, portfolio manager at Unigestion.
Baig added that he expected reflation trades in equity markets to come back into vogue. “We will be back into a cyclical recovery as economies continue to reopen.”
Other analysts said the bond market reaction had been too pessimistic, predicting a broad based economic slowdown in response to Fed rate increases that had not happened yet.
The fall in long-term yields “is only justified if the Fed is making a policy error, choking the economy”, said Peter Chatwell, head of multi-asset strategy at Mizuho. “We think this is far from the truth — the Fed has simply sought to prevent inflation expectations from de-anchoring.”
“Wall Street loves to climb the wall of worry,” added Gregory Perdon, co-chief investment officer at private bank Arbuthnot Latham.
“The facts are that the Fed hasn’t done anything yet.”
Elsewhere in markets, the dollar hung on to strong gains made last week as traders anticipated higher interest rates from holding the US currency. The dollar index, which measures the greenback against major currencies, traded flat at around its highest level in two months.
Brent crude, the international oil benchmark, rose 0.3 per cent to $73.75 a barrel.
Additional reporting by Tommy Stubbington in London
