Global shares fell and the dollar was steady on Wednesday as the Federal Reserve’s mantra that interest rates will stay higher for longer overshadowed the notion that the U.S. central bank will soon pause its tightening cycle as the economy slows.
Fed Chairman Jerome Powell provided fuel for both sides of the argument at the Economic Club of Washington on Tuesday, saying rates might need to move higher if the U.S. economy remained strong, but he reiterated “disinflation” is underway.
MSCI’s U.S.-centric index of stock performance in 47 countries (.MIWD00000PUS) shed 0.56% as stocks on Wall Street slipped. The dollar index rose 0.116% and Treasury yields moved higher.
Financial markets are being driven by excessive liquidity at a time when both bond and equity markets are expensive, said Steven Ricchiuto, U.S. chief economist at Mizuho Securities USA LLC in New York.
“People are beginning to realize these markets are expensive. I don’t think we’re going to be able to sustain a move significantly above 4,100,” Ricchiuto said, referring to the benchmark S&P 500 (.SPX) index.
“As people come to the realization that the Fed is going to be higher for longer and we don’t yet know what the higher is, even if they pause I still think the next move is a rate hike, not a rate cut,” he said.
The Dow Jones Industrial Average (.DJI) fell 0.58%, the S&P 500 (.SPX) lost 1.13% to around 4,120 and the Nasdaq Composite (.IXIC) dropped 1.73%.
Major bourses in Europe were mostly higher, with the pan-European STOXX 600 index (.STOXX) up 0.32%.
“The market is looking for a dovish message where it can almost regardless. Powell said effectively the terminal rate could be higher than the market expects, but the Nasdaq and S&P500 were up (on Tuesday),” said Ben Jones, director of macro research at Invesco.
Aggressive rate hikes by the Fed and other central banks last year to tame inflation hurt equities and boosted the dollar. But those trends have reversed this year on signs that inflation has started to slacken, raising hopes of rate cuts toward the end of 2023.
Futures are pricing in the Fed’s overnight lending rate to peak at 5.173% in July, about 25 basis points higher than last week, and that by December it will have declined to 4.852%, a jump of about 40 basis points since a week ago.
“At the moment (markets are) all about the Fed, but at some point it has to morph into being about growth and earnings growth as well,” said Jones.
U.S. Treasury yields held near one-month highs as investors adjusted for the likelihood that the Fed will hike rates further than previously expected, following the blockbuster U.S. jobs report for January.
The yield on 10-year Treasury notes rose 0.9 basis points to 3.683%, while those on two-year notes eased 0.6 basis points to 3.683%
The Treasury curve measuring the gap between yields on two- and 10-year Treasury notes , seen as a recession harbinger when the short end is higher than longer-dated securities, was inverted at -78.4 basis points.
In Europe, bonds continued to sell off following a sharp tumble the previous day after the European Central Bank said it would cut the interest rate it pays governments on deposits.
Two-year German yields , the most sensitive to any shifts in expectations for interest rates and inflation, rose by as much as 11 bps to 2.725% in early trading, their highest since Jan. 3.
Oil rose for a third straight day as an industry report pointed to a drop in U.S. crude inventories.
U.S. crude was 0.54% higher at $77.56 per barrel and Brent was at $84.01, up 0.38% on the day.
Spot gold added 0.1% to $1,876.52 an ounce.