Stocks tumble as bond markets re-price interest rate expectations

LONDON (Reuters) – Borrowing costs rose in government bond markets and stock markets stalled on Thursday after a surprise rate hike in Canada gave investors their second reminder in the week that the rally in global interest rates is far from over.

Asian markets suffered overnight and the cautious mood continued in Europe as London’s FTSE (.FTSE), Germany’s DAX (.GADXI) and France’s CAC40 (.FCHI) gradually rose higher after starting in the red.

Traders were being driven by the broad repricing taking place in bond markets at when and where interest rates in the world’s largest economies are likely to hit their limit.

In almost a carbon copy of Australia’s surprise rate hike this week, Canada surprised markets on Wednesday by raising interest rates to a 22-year high of 4.75% due to an overheating economy and stubbornly high inflation.

US 10-year Treasury yields, the benchmark for global borrowing costs, are back above 3.8% again, while Europe’s two-year yields have topped 3% for the first time since March, albeit briefly.

“The main theme of it all is selling bonds and realizing that the pause (in central bank rate hike cycles) is not the end,” said Kit Jukes, strategist at Societe Generale.

“We are definitely pricing rate expectations back higher,” he added, explaining that traders are now questioning our long-held view that the US Federal Reserve will end its rate-hiking cycle long before the European Central Bank.

The Federal Reserve, European Central Bank and Bank of Japan will all make interest rate decisions next week.

The steps from the Bank of Canada and the Reserve Bank of Australia mean that Tuesday’s US inflation data will be pivotal to whether the Fed hikes this month or skips a step as was widely expected, said Tapas Strickland, head of market economics at NAB.

The dollar fell slightly on Thursday but remained near a three-month high after rising more than 2.5% against the world’s other major currencies over the past month.

And the CME FedWatch tool showed that markets are now pricing in a 64% chance of the Fed next week, up from 78% the day before. Traders are expecting a 25bp rally in July though.

“The view here was that if both Australia and Canada feel the need for further increases, the Fed is likely to do so too,” said Chris Turner, head of markets at ING.

Troubled times

Overnight in Asia, Chinese stocks (.SSEC) and Hong Kong’s Hang Seng Index (.HSI) fell again and were still feeling the effects of Wednesday’s export data – down 7.5% year-on-year and the biggest drop since January.

“The weak export figures will make observers look for a new round of stimulus policy,” said the strategists at Saxo Markets.

The yen rose 0.2% to 139.80 per dollar after revised data there showed the Japanese economy expanded more than initially thought in the January-March period.

The dollar index, which tracks the greenback against six major peers, was down 0.1% in European trade. The euro rose 0.15% to $1.0717 while the Canadian dollar consolidated gains made after the Bank of Canada’s surprise rally.

Among commodities, US crude futures fell 0.25% to $72.37 a barrel, and Brent crude was $76.76, down 0.25% on the day.

Gold prices stabilized after falling 1% in the previous session, with spot gold rising 0.3% to $1,945.89 an ounce.

In emerging markets, the Turkish lira hit another record low. Signs that the newly re-elected government of Recep Tayyip Erdogan is abandoning an 18-month strategy to keep the currency restrained sent the lira down 7% on Wednesday.

“The thing is, it (the lira) has been artificially stable for so long in the run-up to the election,” said Eric Myerson, SEB’s chief emerging markets strategist, also noting persistent questions about Turkey’s economic policies.

Additional reporting by Ankur Banerjee in Singapore; Edited by Toby Chopra

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