Markets recalibrate as investors adjust to higher US rate hikes

London — European stock indices opened slightly higher on Tuesday while US and European government bond yields rose to multiyear highs, as investors adjusted their expectations for rate hikes following hawkish comments from the US Federal Reserve.

Fed chair Jerome Powell said that the central bank could move “more aggressively” to raise rates to fight inflation, possibly by more than 25 basis points at once.

Markets scrambled to recalibrate the higher possibility of a 50bps hike. On Tuesday morning, money markets were pricing in a 80% chance of a 50 bps hike in May.

At 8.53am GMT, the US 10-year treasury yield was at 2.3497%, its highest since 2019.

RBC Capital Markets’ chief US economist, Tom Porcelli, wrote in a note to clients that during the speech “it was easy to wonder if a 75bps hike or even going intra-meeting is possible”.

“Both outcomes seem incredibly extreme but when we hear Powell talk about inflation he comes off as incredibly anxious to us.”

Eurozone government bond yields also rose, with Germany's benchmark 10-year yield hitting a new 2018 high of 0.51% .

Although Wall Street had closed lower after Powell's comments, stock markets in Europe opened a touch higher, with the MSCI world equity index, which tracks shares in 50 countries, up 0.2% on the day.

The Stoxx 600 was up 0.5%, having climbed high in recent sessions to reach a one-month high. London's FTSE 100 was up 0.6%.

“With positioning light, sentiment weak and geopolitical risks likely to ease over time, we believe risks are skewed to the upside,” wrote JPMorgan strategists in a note to clients.

JPMorgan said that 80% of its clients plan to increase equity exposure, which is a record high.

“We believe investors should add risk in areas that overshot on the downside such as innovation, tech, biotech, EM/China, and small caps. These segments are pricing in a severe global recession, which will not materialise, in our view.”

The conflict in Ukraine continued to weigh on sentiment. US President Joe Biden issue one of his strongest warnings yet that Russia is considering using chemical weapons.

Oil prices continued to rise overnight following news that some EU members were considering imposing sanctions on Russian oil — though Germany said that the bloc was too dependent on Russian oil and gas to be able to cut itself off.

But prices dropped around 8am GMT, with Brent crude futures down 0.9% on the day by 9.16am GMT and West Texas Intermediate futures down 0.7%.

The dollar index was up 0.1% at 98.61, while the euro was a touch lower at $1.1009.

The yen plunged past the 120 level vs the dollar, hurt by the divergent rate-hike expectations for the US and Japan.

“The perception that the JPY may become a funding currency rather than a safe-haven unit after the Bank of Japan made it clear that they do not want to hike rates at present has further helped dollar-yen break above the key 120 threshold,” UniCredit said in a client note.

In cryptocurrencies, bitcoin was up 3.6% at about $42,515 .

Reuters