European stocks and global bonds drop over inflation fears

European equities and global government bonds dropped on Wednesday, as investors looked ahead to central banks starting to remove crisis-era monetary support for financial markets.

The regional Stoxx 600 index fell 1.2 per cent and the UK’s FTSE 100 dropped 1.3 per cent in early trades.

The yield on Germany’s 10-year Bund, a benchmark for borrowing costs in the euro area, rose 0.03 percentage points to minus 0.075 per cent, around its highest in two years. The yield on Italy’s equivalent bond raced 0.05 percentage points higher to 1.147 per cent.

The moves came ahead of the US Federal Reserve releasing minutes of its latest monthly meeting on Wednesday. The yield on the 10-year US Treasury bond, which has climbed from about 0.9 per cent at the start of this year, rose 0.03 percentage points to 1.669 per cent.

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Purchases

Fed policymakers, whose moves are closely followed by other global rate-setters, have insisted the bank will continue its £120 billion (€98 billion) of monthly bond purchases until the US labour market recovers from the pandemic. But following a lengthy stock market rally since last March, a bonanza corporate earnings season on both sides of the Atlantic and a jump in US inflation, stock market investors are increasingly alert for any signals central banks’ thinking will change.

"There are two reasons for markets to consolidate now," said Paul Jackson, head of asset allocation research at Invesco. Global stocks had already rallied on the back of a US economic rebound and coronavirus vaccines. "A lot of good news is already in the price and it gets harder to see where the next catalyst for a further rally comes from."

A further concern was “global growth that is good enough that you get more inflation and central banks remove their support”, he added.

The Stoxx has gained about 55 per cent since March last year. The S&P 500 in the US has risen more than 80 per cent over the same period.

Rising bond yields in the euro area, which can dent equity valuations by lowering the relative value of dividends paid by companies, were likely to cap further rises in the Stoxx, which hit an all-time high on May 10, Bank of America strategists said.

“Our macro assumptions imply a further 5 per cent upside for the Stoxx 600,” the BofA strategists said in a research note, as improving economic conditions related to vaccine rollouts were “partly offset by the drag from rising real bond yields”.

Inflation

Inflation, which also erodes the real returns from stocks and bonds “is now an issue in the euro area too”, said Maya Bhandari, portfolio manager at Columbia Threadneedle, after factory activity and retail sales boomed in April. The European Central Bank last week raised its growth and inflation expectations for the currency bloc, setting the scene for further debate over whether it should slow the pace of its pandemic-driven bond-buying.

The euro was steady against the dollar, purchasing $1.222, after rising on Tuesday to its strongest level against the US currency since January. The dollar index, which measures the greenback against trading partners’ currencies, was flat.

Brent crude, which briefly touched $70 a barrel on Tuesday for only the second time during the pandemic, fell 1.5 per cent to $67.79. – Copyright The Financial Times Limited 2021