Stocks rally pauses, bond markets ponder risks for U.S. economy

By Tom Wilson and Koh Gui Qing

LONDON/NEW YORK (Reuters) – The U.S. and European equities rally paused on Wednesday as investors took stock of economic and geopolitical risks, while oil prices jumped back around $4 on the prospect of more Russian sanctions.

The broad Euro STOXX 600 fell 0.6% after three positive sessions that had taken the index back to levels reached before Russia invaded Ukraine.

By late morning, the Dow Jones Industrial Average had lost 0.18%, to 35,229.04, the S&P 500 was down 0.25%, and the Nasdaq Composite was little changed.

The MSCI world equity index, which tracks shares in 50 countries, was also little changed.

The relative cheer among stock investors contrasted with the circumspection in the bond market, where some investors are betting aggressive tightening of policy by the U.S. Federal Reserve could harm the world’s biggest economy over the longer term.

“I’m very worried that U.S. equities do not price any risk of slowdown in the U.S. economy – that is extremely worrying,” said Ludovic Colin, a senior portfolio manager at Swiss asset manager Vontobel.

The widely tracked U.S. 2-year-10-year Treasury yield curve briefly inverted on Tuesday for the first time since September 2019. [US/]

Longer-dated yields falling below shorter ones indicate a lack of faith in future growth, with 10-year yields falling beneath 2-year rates widely viewed as a harbinger of recession.

Sebastien Galy, senior macro strategist at Nordea Asset Management, said fixed income and equity markets were diverging.

“Equity markets are overly optimistic and the fixed income markets are probably being overly pessimistic.”

An inverted Treasury curve has in recent decades been followed by a recession within two years, including the 2020 downturn caused by the COVID-19 pandemic.

Benchmark indexes in Frankfurt and Paris lost 1.5% and 1.1% respectively, with London shares up a touch at 0.19%.

A day after rising above 0% for the first time since 2014, Germany’s two-year bond yield was up six basis points at 0.01% – keeping the previous day’s highs in sight.

Shares rallied in Asia overnight after Ukraine proposed on Tuesday it adopt neutral status, a move seen by investors as a sign of progress in face-to-face peace negotiations.

On the ground, however, reports of attacks continued and Ukraine reacted with scepticism to Russia’s promise in negotiations to scale down military operations around Kyiv.

MSCI’s broadest index of Asia-Pacific shares outside Japan jumped 1.46% to its highest in nearly a month, with most Asian stock markets in positive territory.

JAPAN IN FOCUS

The benchmark U.S. 10-year yield was last at 2.3762%, having risen as high as 2.557% on Monday for its highest since April 2019, as traders positioned themselves for quick-fire increases to U.S. interest rates.

The impact of rising U.S. yields played out elsewhere, dragging Japanese government bond yields in their wake in a threat to Japan’s ultra-loose monetary policy.

The Bank of Japan increased efforts to defend its key yield cap on Wednesday, offering to ramp up buying of government bonds across the curve, including unscheduled emergency market operations.

The widening gap between U.S. and Japanese yields has caused the yen to weaken sharply, but it managed to regain some lost ground on Wednesday.

The Japanese currency rose 0.9% to 121.80 per dollar, compared with Monday’s low of 124.3, amid concerns Japanese authorities might step in to bolster the yen. [FRX/]

Elsewhere in currency markets, the euro rose 0.6% to $1.1157, its highest in four weeks, supported by the Russia-Ukraine peace talks.

In energy markets, oil prices jumped around $4 on supply tightness and the growing prospect of new Western sanctions against Russia even as Moscow and Kyiv held peace talks.

Brent crude LCOc1 futures were up $3.96, or 3.6%, at $114.19, while U.S. crude rose 3.66% to $108.05 per barrel.

(Reporting by Tom Wilson in London, additional reporting by Dhara Ranasinghe and Alun John in Hong Kong; Editing by Bernadette Baum and Mark Potter)