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Dollar and Treasury yields surge on Fed outlook

Thursday 11:00 GMT

Overview

Stock markets are trading cautiously as Treasury yields hit fresh highs after the Federal Reserve’s decision to raise interest rates for only the second time since the financial crisis.

The prospect of the US central bank perhaps having to tighten policy faster than expected to reflect any additional boost to growth from president-elect Trump’s fiscal plans is lifting the dollar to a 14-year peak and pressuring gold.

Hot topic

The Fed’s decision on Wednesday to increase short-term official borrowing costs by 25 basis points was expected by the market.

But the monetary guardian is also eyeing a faster pace of tightening next year, with policymakers now forecasting three quarter-point increases in 2017, up from two previously.

That has hit bond prices, pushing yields sharply higher. The 2-year US bond yield, which is particular sensitive to monetary policy expectations, is up another 5 basis points to 1.29 per cent, its highest since August 2009. Futures markets are pricing in a 48 per cent chance of another rate hike at the Fed’s March meeting.

The benchmark 10-year Treasury yield is adding 11bp to 2.63 per cent, taking its rise since Mr Trump was elected US president to more than 75bp. In contrast, the 10-year bonds of Germany and Japan respectively are up 7bp but offering just 0.37 per cent, and gaining 3bp to 0.09 per cent, the relatively meagre yields reflecting their central banks’ continued monetary easing modes.

And this divergence is bolstering the buck. The dollar index, which measures the greenback against a basket of its peers, is following up Wednesday’s 0.7 per cent gain with an additional 0.9 per cent advance to 102.65, its highest in 14 years as the euro falls below $1.05.

What to watch

The Bank of England holds its final policy meeting of the year later on Thursday and is expected at 12.00GMT to keep rates steady at 0.25 per cent.

Minute’s of the debate will also be published, providing traders with additional clues to the Monetary Policy Committee’s thinking.

In the meantime, the UK pound is down 0.5 per cent at $1.2530 but strengthening by 0.3 per cent to £0.8356 per euro after data released earlier in the day showed UK retail sales for November growing 0.2 per cent. The 10-year gilt yield is jumping 11bp to 1.49 per cent in sympathy with peers.

Equities

Wall Street pulled back from its record highs on Wednesday as the Fed news pushed up borrowing costs and propelled the dollar, both trends often deemed potentially damaging to US corporate profits.

Index futures suggest the S&P 500 will open at 2,261, recovering 8 of the 18 points lost in the previous session. But its not enough to fully reignite the worldwide bullishness of recent weeks.

The pan-European Stoxx 600 is up 0.3 per cent as the UK’s FTSE 100 sheds 0.1 per cent but Germany’s Dax gains 0.6 per cent, the latter bolstered by the weaker euro.

Japanese stocks see-sawed in and out of negative territory, leaving the Topix up 0.3 per cent at the close. Tokyo was supported by the yen slipping towards ¥118 per dollar — currently off 1.1 per cent to ¥118.33 — its weakest level since February.

Australia’s S&P/ASX 200 fell 0.8 per cent, weighed down by commodity and telecommunications stocks.

Hong Kong’s Hang Seng lost 1.8 per cent, led by heavy declines for rate-sensitive sectors like property and financials, while mainland China’s Shanghai Composite was down 0.7 per cent. Investors noted another sharp rise in the Hong Kong interbank borrowing rate for offshore renminbi overnight loans (CNH Hibor), a sign perhaps that Beijing was looking to drain liquidity from the offshore market.

Forex

The stronger dollar has been putting pressure on emerging market currencies as fears build that higher rates will attract capital back to the US.

China’s renminbi (CNY) is off 0.4 per cent to an eight-and-a-half-year low of Rmb6.9315 per dollar. The Indonesian rupiah is slipping 0.7 per cent and the South African rand is down 1.5 per cent.

The Mexican peso is 0.9 per cent softer at 20.6540 per buck and South Korea’s won is off 0.5 per cent after the central bank kept interest rates on hold.

The Australian dollar is a steadier performer against its US counterpart, shedding just 0.2 per cent to $0.7384 in the wake of employment data that showed the country’s economy added 39,100 jobs in November.

Commodities

Gold is following up Wednesday’s $15 slide by losing a further $14 to $1,130 an ounce, its cheapest price in 10 months. The bullion tends to balk at a firmer dollar and rising borrowing costs.

Energy markets are adding to their recent strong rally in the wake of the agreement by Opec and other producers to cut output. Brent crude, the global oil benchmark, is up 1 per cent at $54.42 a barrel while West Texas Intermediate is gaining 0.5 per cent to $51.28.

Additional reporting by Peter Wells in Hong Kong

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