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An employee passes share price information displayed on an electronic ticker board inside the London Stock Exchange Group’s offices in London, the UK. Picture: BLOOMBERG VIA GETTY IMAGES/LUKE MACGREGOR
An employee passes share price information displayed on an electronic ticker board inside the London Stock Exchange Group’s offices in London, the UK. Picture: BLOOMBERG VIA GETTY IMAGES/LUKE MACGREGOR

London — European markets rallied on Wednesday, led by banks, after news that the European Central Bank (ECB) would hold an emergency meeting on the recent bond market sell-off ahead of what is expected to be the most aggressive rise in US interest rates since 1994.

The hope of a quiet run in to what is forecast to be a three-quarter point hike by the Federal Reserve later in the day were quickly dashed as the ECB’s unexpected meeting — less than week after its last scheduled one — triggered a rush of activity.

The euro jumped almost 0.75% to $1.0487, pushing the dollar index off a 20-year high in the process.

Italy’s 10-year bond yields, which have risen to eight-year highs as eurozone debt worries have returned, charged back under 4% putting them on course for the biggest daily fall since the start of March.

Italy’s stock market also jumped 2% as its banks leapt 6%. Europe more broadly climbed 0.5% while the euro’s rise also scored a 16-month high against the pound as it suffered the Brexit blues again.

“The best laid plans of the ECB and President Lagarde to normalise policy in an orderly fashion have just run into the reality of the bond market,” said Societe Generale strategist Kit Juckes.

“The big question is whether it is even possible [to normalise policy] or we are just stuck in the same old world where we need some kind of asset buying programme to hold the bond market together,” he added.

The worries about rising borrowing costs and inflation globally have been hammering financial markets all year. Economists fear drastic Fed action in particular could tip the world into recession and the degree to which the US central bank lifts rates later is under intense scrutiny.

Treasury yields had hit decade highs overnight and the dollar a 20-year peak as futures implied it was near certain the Fed would hike by 75 basis points to a range of 1.50-1.75% later on Wednesday.

That would be the biggest increase since 1994, and markets already have rates reaching 3.75-4.0% by the end of the year.

“Against a backdrop of sky-high inflation, rising rates, and growing recession concerns, the S&P 500 has had its worst start to the year since 1962,” analysts at Goldman Sachs said. “A likely coming peak in inflation is probably not sufficient to see the bottom, and similar past drawdowns have only ended when the Fed has shifted towards easier policy.”

That could be some time away and the global investment bank is recommending investors reduce portfolio duration and increase exposure to real assets.

With so much priced in, a few brave investors who are buoyed by the ECB, were looking for bargains. S&P 500 futures were up 0.7%, while Nasdaq futures rose 0.75% and Dow futures added 0.4%.

MSCI’s broadest index of Asia-Pacific shares outside Japan was o course to close little changed, but is down sharply on the week.

Japan’s Nikkei lost 1.1%, though sentiment was helped by a survey showing an improvement in confidence among local manufacturers.

Chinese shares bucked the trend with a gain of 1.3%. Data on the country’s retail sales and industrial output for May were a little better than forecast, but still showed the drag from coronavirus lockdowns.

Authorities in Beijing said on Tuesday the city was in a “race against time” to get to grips with its most serious outbreak since the pandemic began.

Yield advantage

The ECB’s move allowed bond markets everywhere to rally after their recent hammering, with 10-year Treasury yields dipping to 3.43% and away from Tuesday’s peak of 3.498%. Bond yields drop as the price of the securities rise.

Two-year yields stood at 3.37%, after touching the highest since 2007 at 3.456% overnight. Given many US borrowing rates are linked to yields, financial conditions have already tightened markedly there even before the Fed hikes.

Treasury yields are also the benchmark for bonds across the globe, so financial conditions are tightening pretty much everywhere. That is a major headwind for consumer spending power, while pressuring emerging market countries that borrow in dollars.

It has also tended to boost the US dollar, which had hit a 20-year high against a basket of currencies before the ECB’s news, led by big gains on the low-yielding Japanese yen.

The dollar was trading at 134.66 yen, having reached heights last visited in 1998 at 135.60.

The latest gains came as the Bank of Japan increased its bond buying to keep yields near zero, even as much of the rest of the world tightens policy. Still, the sheer pressure on the yen and bonds has stoked speculation the central bank could be forced to amend its yield control policy at a meeting on Friday.

Surging yields and a sky-high dollar have been a burden for gold, which was near its lowest in a month at $1,814 an ounce.

Oil prices edged up after Opec stuck to its forecast that world oil demand will exceed pre-pandemic levels in 2022. Brent was 31c firmer at $121.48 a barrel, while US crude rose 30cc to $119.23.



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