Wall Street seen opening higher but U.S. recession priced in

By Carolyn Cohn

LONDON (Reuters) – U.S. stock index futures rose on Friday, indicating a higher open on Wall Street, as investors digest warnings from U.S. Federal Reserve officials on U.S. interest rates, but the U.S. bond yield curve remains priced for a recession.

S&P futures gained 0.8%, recovering poise after the S&P 500 index dipped 0.3% and U.S. bond yields rose on Thursday following comments from St. Louis Fed President James Bullard.

Bullard said interest rates might need to hit a range from 5-5.25% from the current level of just below 4.00% to be “sufficiently restrictive” to curb inflation.

That was a blow to investors who had been wagering rates would peak at 5% and saw Fed fund futures sell off as markets priced in more chance that rates would now top out at 5-5.25%, rather than 4.75-5.0%.

“The Fed has come back through their speeches and pushed back against the market narrative – we are not going to see a pivot,” said Arun Sai, senior multi-asset strategist at Pictet Asset Management.

Sai said markets were currently “running on fumes” and would likely switch focus to the real economy’s response to rising rates, such as anecdotal signs of slowdown in the U.S. labour market.

GRAPHIC: Implied Fed terminal rate – https://fingfx.thomsonreuters.com/gfx/mkt/akveqzmxrvr/One.PNG

The MSCI world equities index rose 0.33% but was heading for a 0.5% loss on the week, coming off recent two-month highs.

Inflows into global equity funds hit their highest level in 35 weeks in the week to Wednesday, according to a report from Bank of America (BofA), as investor optimism brightened.

Euro zone banks, meanwhile, are set to repay 296 billion euros in multi-year loans from the European Central Bank next week, the ECB said on Friday, in its latest step to fight runaway inflation in the euro zone.

This is less than the half a trillion euros that analysts were expecting but still the biggest drop in excess liquidity since records began in 2000.

The yield on Germany’s 10-year government bond, the benchmark for the euro zone, was up 3.6 basis points at 2.06%. European stocks gained 1.2%, with banks up 1.4%.

The European Central Bank may need to raise interest rates so much that they dampen growth as it fights sky-high inflation, while any runoff in the ECB’s bond holdings must be “measured and predictable”, its chief Christine Lagarde said earlier on Friday.

“The ECB will be wanting to show that it’s a strong institution and that it’s willing to fight inflation,” Jim Leaviss, Chief Investment Officer, Public Fixed Income at M&G Investments told the Reuters Global Markets Forum.

“There will come a time during 2023 where rates will come down from the ECB because the recessionary impulse will be quite severe.”

Britain’s FTSE rose 1% to two-month highs, a day after finance minister Jeremy Hunt announced tax rises and spending cuts in an effort to reassure markets that the government was serious about fighting inflation.

U.S. two-year yields rose 3.8 bps to 4.49%, retracing a little of last week’s sharp inflation-driven drop of 33 basis points to a low of 4.29%.

That left them 69 basis points above 10-year yields, the largest inversion since 1981 and an indicator of impending recession. [US/]

The dollar fell 0.2% to 106.5 on a basket of currencies, after touching a three-month trough of 105.30 early in the week.

The U.S. currency dropped 0.26% to 139.82 yen <JPY=EBS. Sterling rose 0.45% to $1.1921.

The euro held at $1.0375, having eased from a four-month peak of $1.0481 hit on Tuesday as some policymakers argued for caution on tightening.

MSCI’s broadest index of Asia-Pacific shares outside Japan rose 0.2%.

Chinese blue chips dropped 0.45% amid reports that Beijing had asked banks to check liquidity in the bond market after soaring yields caused losses for some investors.

There were also concerns that a surge in COVID-19 cases in China would challenge plans to ease strict movement curbs that have throttled the economy.

Japan’s Nikkei slipped 0.1% as data showed inflation running at a 40-year high as a weak yen stoked import costs.

Oil was on track for a second weekly decline, pressured by concern about the weakening demand in China and further U.S.interest rate rises [O/R]

Brent crude hit four-week lows and was down 0.8% at $89.07 a barrel. U.S. crude was down 0.5% at $81.23 a barrel.

Gold was flat at $1,762 an ounce. [GOL/]

(Additional reporting by Wayne Cole in Sydney and Lisa Mattackal in Bengaluru, editing by Sam Holmes, Simon Cameron-Moore and Louise Heavens)