Government bonds come under renewed pressure and US stocks slip

Government bond prices fell on Wednesday as investors on both sides of the Atlantic bet that central banks would act aggressively to combat inflation.

The yield on the 10-year US Treasury note rose 0.08 percentage points to 2.92 per cent, while the more policy-sensitive two-year note climbed 0.12 percentage points to 2.66 per cent. Yields rise when prices fall.

The moves followed stronger than forecast results from a closely watched survey of the US manufacturing sector. The Institute for Supply Management’s factory activity index rose to 56.1 in May, higher than consensus forecasts of 54.5 and well above the 50 level that indicates expansion.

Markets have been volatile in recent weeks as investors grappled with conflicting signs about the health of the global economy and predictions about the future paths of inflation and interest rates. Wednesday’s manufacturing data was seen as a sign that the Federal Reserve has more leeway to lift rates without pushing the US economy into recession.

Investors now expect the fed funds rate to reach 3 per cent by next February, according to futures markets, up from 2.8 per cent at the start of the week.

“Clearly, the initial post-shock surge in activity is over, but output is still increasing at a healthy pace and some industries, notably autos, have a long way to go before a full recovery is complete,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

The pressure on Treasuries also came as the Fed on Wednesday began the long process of quantitative tightening, reducing its balance sheet by allowing bonds that it bought to mature without replacing them.

The prospect of higher rates weighed on stock markets, with the benchmark S&P 500 index and tech-dominated Nasdaq Composite each closing 0.7 per cent lower. After several weeks of wild swings, the broad S&P index ended May at almost exactly the same level it started.

Some analysts warned of further declines to come. Anna Stupnytska, global economist at Fidelity International, said: “When we look at various historical episodes, we think equities have not found the trough yet, given headwinds of further aggressive tightening from central banks, the risk related to the war in Ukraine, which is clearly systemic, and commodity markets performing strongly.”

European assets followed a similar pattern, with the Stoxx 600 stock index falling 1 per cent while the yield on Germany’s benchmark 10-year Bund rose 0.06 percentage points, to 1.18 per cent.

Data on Tuesday showed eurozone inflation hit a record high in May, though worse than predicted German retail sales data on Wednesday exacerbated worries about slowing economic growth in the currency bloc.

European Central Bank policymakers will meet next week to discuss how quickly the central bank should raise interest rates to combat inflation without pushing the region into recession.

EU leaders also earlier this week struck a deal to ban most Russian oil imports. Brent crude, the international oil benchmark, rose 0.6 per cent to $116.29 a barrel on Wednesday.

In Asia, Hong Kong’s Hang Seng fell 0.6 per cent, as investors weighed the easing of coronavirus restrictions in Shanghai following two months of lockdown against growth concerns. A privately compiled gauge from Caixin showed that activity in China’s manufacturing sector had contracted for a third consecutive month.