US treasury yields near highs as rising oil prices prod inflation

London/Singapore — Stocks struggled for headway on Wednesday while US treasury yields held near multiyear highs as surging oil prices stoked inflation and set the scene for the US Federal Reserve to project interest rates staying higher for longer.

In Europe, sterling came under pressure after data showed Britain’s high inflation rate fell unexpectedly in August, prompting speculation that the Bank of England could pause its historic run of interest-rates hikes as soon as Thursday.

Brent crude futures fell 1% and eased off 10-month highs. But at about $93.50 a barrel, prices remain up 30% in three months as Saudi Arabia and Russia reduce output.

Higher energy costs led to a bigger-than-expected spike in Canadian inflation, lifting the loonie on Wednesday and triggering selling in bond markets around the world.

The Federal Reserve is expected to leave rates unchanged at the current range of between 5.25% and 5.5% when it concludes a two-day meeting. Its policy statement is expected at 6pm GMT, followed by a media conference with Fed chief Jerome Powell.

“While the Fed is not expected to change their policy rate today, the US rate market has been scaling back expectations for rate cuts in 2024 ahead of today’s FOMC meeting that has helped to lift short-term US rates,” said MUFG senior currency analyst Lee Hardman, referring to the Fed's rate setting body.

Two-year treasury yields were down 2 basis points in London trade at 5.09%, having risen sharply on Tuesday, when five- and 10-year Treasury yields reached 16-year highs.

Benchmark 10-year treasury yields were last trading at 4.35%, having hit 4.371% overnight.

Waiting on the Fed

The Fed meeting leads a week jammed with central bank meetings, with policy announcements in Sweden, Switzerland, Norway, Britain and Japan all due later in the week.

World stock markets were largely subdued ahead of the Fed rate decision.

European stocks were up 0.4% and US equity futures were flat.

In Asia, MSCI's broadest index of Asia-Pacific shares outside Japan fell 0.6% with Hong Kong stocks the biggest drag as China left lending rates on hold. Japan's Nikkei fell 0.6%.

Sterling underperformed most other major currencies after the British inflation data, and was last trading 0.25% lower at $1.2365.

UK gilt yields fell sharply as investors slashed bets for a rate hike on Thursday, with two-year yields last down almost 13 bps at 4.86%.

“Although a positive report, when also considering the recent high pay growth numbers, we do not on balance think today's softer numbers will change tomorrow's decision — we continue to expect a 25bp hike to 5.50% as our baseline case,” said Investec economist Ellie Henderson.

“But the risks around this have changed and more clearly it calls into question the November rate decision.”

Japan’s yen, meanwhile, continued to face pressure, prompting a riposte from Japan’s top financial diplomat.

Kanda Masato told reporters that Japanese authorities were always in close communication with US counterparts and that he wouldn’t rule out any options if “excessive moves persist.”

The yen is down 11% on the dollar in 2023 as expectations firm for US rates to stay high and Japanese rates to stay low. The yen hit a 10-month trough of ¥147.95 to the dollar late last week and was last trading at about ¥148.

Benchmark 10-year Japanese government bonds are at 0.72%, but have been creeping towards the Bank of Japan’s adjusted tolerance for yields 1% either side of zero.

The euro was a touch firmer at $1.069. Commodity exporters’ currencies were firm, with the New Zealand dollar holding modest recent gains at $0.5940 after strong dairy price gains at an overnight auction.

The Australian dollar held at $0.6464 and analysts said markets might be more sensitive to a dovish surprise from US policymakers.

“We think that the market may already be semi-braced for a hawkish pause,” DBS strategist Eugene Low said in Singapore.

“Short of the Fed delivering beyond what is reasonably expected — that is, hiking rates or removing two cuts per year — we think upside to two-year and three-year dollar rates may be limited.”

Rising yields have kept a lid on gold prices, with spot gold last trading at $1,929/oz.

Reuters