European stocks falter as bond yields rise after ECB shift

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European stock indexes faltered on Friday, despite strong Amazon earnings, while a sell-off in bonds briefly pushed Germany’s 5-year yield positive for the first time in four years after the European Central Bank was more hawkish than expected.

Asian equities held firm overnight after better-than-expected earnings from Amazon, in contrast to the heavy selling on Thursday following Facebook owner Meta Platforms’ earnings miss.

The rebound in sentiment did not persist in European trading, with the STOXX 600 down 1.2% at 1150 GMT.

But Nasdaq futures were up and the MSCI world equity index was set for its best week so far this year.

“What the earnings season tells you is that the underlying prospects of companies are still pretty good,” said Michael Metcalfe, head of macro strategy at State Street.

“I tend to think that the buy-the-dip mentality is still there.”

According to Reuters, “market sentiment has been dominated by speculation about the trajectory for rate hikes from major central banks this year, as pressure mounts for policy moves to combat inflation. Rate hikes typically hurt riskier assets such as stocks.”

In a move labeled by analysts as a “pivot,” European Central Bank President Christine Lagarde was more hawkish than expected at the central bank’s meeting on Thursday. She acknowledged mounting inflation risks and declined to repeat her previous guidance that an interest rate increase this year was “very unlikely.” 

The euro jumped on Thursday and extended its gains on Friday, hitting a three-week high. At 1152 it was up 0.3% on the day at $1.14745. 

“Central banks are actively trying to tighten financial conditions… they are moving faster than expected,” said Colin Asher, senior economist at Mizuho.

European government bond yields also rose. Germany’s 5-year yield briefly turned positive as traders priced in ECB rate hikes this year. Germany’s 2-year yield was set for its biggest weekly rise since 2008.

“In other markets, we’ve got a series of hikes priced in and so it may well be now that European markets have to digest the possibility of that,” said State Street’s Metcalfe.

“When central banks have pivoted, rate markets have pivoted even more and have tended to overshoot, so I think there’s probably a risk of that in Europe.”

The U.S. 10-year yield was at 1.812%. Investors expect the U.S. Federal Reserve to begin hiking rates at its March meeting IRPR.

Morgan Stanley said markets were now facing “the largest quantitative tightening in history” from May onwards, with G4 central bank balance sheets set to shrink by $2.2T over the next 12 months.

“We forecast the ECB’s balance sheet to actually shrink faster than the Fed’s from May 2022 to May 2023.” Morgan Stanley’s Andrew Sheets said.

But Australia’s central bank was still content to keep policy ultra-loose in its quarterly statement on monetary policy, even as it sharply revised up its outlook for inflation and projected unemployment at 50-year lows.

The Bank of Japan brushed aside the view that it could follow in the footsteps of its more hawkish U.S. and European peers.

The dollar index was steady at 95.205, while the Japanese yen was at 114.85 and the Australian dollar was down 0.7% at $0.709.

Source: Reuters

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