US government bonds sell off after hawkish comments by Jay Powell

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US short-term government bond yields soared to levels last seen in 2007 and stocks fell a day after Federal Reserve chair Jay Powell warned that interest rates would peak at a higher level than previously expected.

The two-year Treasury yield, which is particularly sensitive to monetary policy, rose 0.16 percentage points to 4.73 per cent. Wall Street equities also extended steep falls from the previous day. The blue-chip S&P 500 fell 1.1 per cent and the Nasdaq Composite dropped 1.3 per cent.

Those sharp moves came after Powell said on Wednesday the US central bank had “some ways to go” in its quest to tame inflation, and that the “terminal” point at which interest rates will top out will be higher than anticipated.

Powell’s comments followed a decision by the Fed’s rate-setting panel on Wednesday to lift borrowing costs by 0.75 percentage points for the fourth consecutive time, taking the Fed’s target range to 3.75 per cent to 4 per cent.

Traders are now betting that interest rates in the world’s largest economy will peak at around 5.15 per cent in June next year, compared with 5 per cent before Wednesday’s Fed meeting, according to trading in federal funds futures.

Projections of higher interest rates helped the dollar index, which tracks the greenback against six peers including the euro and sterling, to strengthen 0.8 per cent on Thursday.

Mike Zigmont, head of trading and research at Harvest Volatility Management, said Powell’s statements were likely to snuff out investor optimism that had helped US share indices rise over the past fortnight.

“We just set a new sentimental tone and it’s bearish. I don’t know if it’s going to get ugly but optimism is out the window for a while.”

The prospect of higher borrowing costs can dent the appeal of more speculative stocks, whose cash flows and earnings are forecast further out into the future.

Europe’s regional Stoxx 600 fell 1.7 per cent. London’s FTSE was down 0.5 per cent immediately after the Bank of England raised UK borrowing costs by 0.75 percentage points in an attempt to lower inflation, bringing its main interest rate to 3 per cent. The BoE noted, however, that it expected the bank rate to peak at a lower level than markets anticipated ahead of the meeting.

The pound slipped following the news, extending earlier losses against the dollar to trade 1.8 per cent lower at $1.118. Traders now expect UK interest rates to reach just above 4.6 per cent in September next year, compared with 4.75 per cent prior to the central bank’s announcement.

Ruth Gregory, senior UK economist at Capital Economics, nonetheless anticipated interest rates to reach 5 per cent, with inflation proving “stickier than the bank expects”.

Asian equities fell sharply after China’s National Health Commission quashed rumours that the country was preparing to ease its strict zero-Covid approach.

“[We must] work to control sudden outbreaks of the pandemic . . . as quickly and at as low cost as possible,” the NHC said.

The statement from China’s top health authority sent domestic stocks lower on Thursday morning, with the benchmark CSI 300 and Hong Kong’s Hang Seng index down 0.8 per cent and 3.1 per cent respectively.

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