Fed’s faster-than-expected rate hike signal triggers world stock sell-off

Stock markets were deep in the red and some key government bond yields climbed to their highest in years on Thursday after the Federal Reserve signalled the possibility of faster-than-expected US rate hikes and stimulus withdrawal. The 10-year Treasury note’s yield briefly topped 1.75%, approaching its 2021 high, deepening one of the biggest weekly selloffs in U.S. government debt in years.

The benchmark note’s yield rose as much as 4.6 basis points to 1.751%, within three basis points of last year’s high, reached on March 30. After retreating to around 1.73% it remains about 22 basis points higher on the week, on track for its biggest weekly increase since June 2020.

Both Asia and Europe’s bourses fell heavily after Wall Street’s tech-heavy Nasdaq plunged more than 3% on Wednesday and 2- and 5-year Treasury yields, important drivers of global borrowing costs, surged to post-Covid pandemic highs.

Minutes from the Fed’s December meeting had shown that a tight jobs market and unrelenting inflation could require the US central bank to raise rates sooner than expected and begin reducing its overall asset holdings – a process known as quantitative tightening (QT).

Early European trading saw the STOXX 600 share index lose 1.3%, erasing all of its gains for the year that had sent it to record highs.

Asia has seen sharp falls too. Australian shares slid 2.7% in their biggest daily percentage drop since early September 2020, and Japan’s Nikkei fell 2.9%, its biggest daily fall since June.

“Some people are quite spooked by the minutes from the Fed that they could be tightening faster,” said Carlos de Sousa, an emerging markets strategist and portfolio manager at Vontobel Asset Management.

“Maybe the market is overreacting a bit, though. The fact they are discussing this (quantitative tightening) doesn’t mean they are going to do it,” he said, adding that he expected 1-3 rate hikes in 2022 but would be surprised if QT did happen this year.

The minutes showed that Fed officials were uniformly concerned about the pace of inflation, which promised to persist, alongside global supply bottlenecks, “well into” 2022.

The Nasdaq’s 3% drop on Wednesday was its biggest one-day percentage decline since last February and the S&P 500 fell the most since Nov. 26, when news of the Omicron variant first hit global markets.

“There is a risk that the Fed might fall into the trap of making policy errors because they do have to perhaps hike interest rates faster than expected, but given the timing of their exit from quantitative easing, it could coincide with a slowdown in the economic cycle and also a decline in inflation on base effects,” said Casanova.

The policy-sensitive U.S. 2-year yield hit a new 22-month top of 0.863% while the 5-year yield hit highs last seen in February 2020 at 1.459%.

In Europe too, 10-year Germany Bund yields, which rolled over into a new benchmark, rose to -0.05%, the highest level since May 2019, Refinitiv data showed.

Analysts said that while the rollover into a new contract made the move in Bund yields appear large, even if measured on a continuous basis, yields were at new multi-month highs.

Higher U.S. yields continued to support a firm dollar , though the currency gave back some ground against the yen after touching five-year highs earlier this week, falling 0.21% to 115.86.

The euro weakened 0.05% to $1.1307 while the dollar index crept up by the same margin to 96.228.

In commodity markets, global benchmark Brent crude steadied at $79.14 per barrel and U.S. crude dipped to $80.08 a barrel after OPEC+ producers agreed to boost production and on a surge in U.S. stockpiles.

Spot gold was down 0.8% at $1,794 per ounce, with higher U.S. bond yields dulling the lustre of the precious metal.