Dollar breaks higher and shares fall after Fed's Powell strikes hawkish tone

[January 27, 2022]  By Tommy Wilkes

LONDON (Reuters) - Stocks fell on Thursday, U.S. two-year bond yields rocketed to 23-month highs and the dollar busted out of its recent range after the Federal Reserve stuck to plans for an interest rate rise in March and Chair Jerome Powell warned about inflation.

The Euro STOXX fell 0.19% while Germany's DAX lost 0.52%.

Wall Street had plunged on Wednesday, reversing earlier gains after Powell's press conference, and looked set to open slightly lower on Thursday.

Stocks -- which have fallen sharply from record highs in 2022 -- were way off the day's lows, however, and selling was not nearly as aggressive as in recent sessions.

In Asia, shares slumped to their lowest in nearly 15 months. Britain's energy and bank-heavy FTSE 100 bucked the trend with a 0.3% gain.

Investors globally have dumped riskier assets in 2022 and sought safety as they brace for the end of nearly two years of exceptionally cheap and plentiful cash.

"What cheap money has done is provide a safety blanket from bad news," said Jane Foley, an analyst at Rabobank.
 

"But as this comfort blanket is pulled away, investors will be more exposed and I suspect this will create a more volatile environment for asset prices."

In its latest policy update on Wednesday, the Fed indicated it was likely to raise U.S. interest rates in March, as widely expected, and reaffirmed plans to end its pandemic-era bond purchases that month before launching a significant reduction in its asset holdings.

But in a follow-up news conference Powell warned that inflation remained above the Fed's long-run goal and supply chain issues may be more persistent than previously thought.

Adding to investors' nervousness are rising concerns over political tension between Russia and Ukraine. That has exacerbated worries over tight energy market supply, keeping oil prices elevated at multi-year highs.

Fed funds futures showed traders pricing in as many as five increases by December, after previously fully pricing for four. [FEDWATCH]

DOLLAR BREAKS HIGHER

Expectations of Fed tightening sent the policy-sensitive U.S. two-year yield to 1.208%, levels last reached in February 2020. The benchmark 10-year yield slipped slightly to 1.835% having hit a high of 1.88% on Wednesday.

Passersby wearing protective face masks walk past a stock quotation board, amid the coronavirus disease (COVID-19) pandemic, in Tokyo, Japan January 25, 2022. REUTERS/Issei Kato

The spread between the 10 and two-year bond yields fell to its narrowest since late 2020 as investors priced in a faster pace of rate rises in the medium-term.

This in turn helped the dollar to its highest since June 2020 and sent the euro to its lowest in 19-months. The single currency dropped 0.5% to $1.1182.

Investors expect the speed at which the Fed tightens policy to be the major determinant of risk sentiment in the coming months, although the U.S. central bank has said how quickly it hikes will depend on economic data and especially inflation.

"Powell (is) not committing to the size or the frequency of rate hikes and also the timing of the balance sheet reduction. I think that buys him a bit of wiggle room as to how quickly and with what velocity he wants to normalise monetary policy in the U.S." said David Chao, global market strategist, Asia Pacific (ex-Japan) at Invesco.

Oil prices reversed earlier losses to hover above $90 per barrel, a level last seen in October 2014, on the festering tension between Russia and Ukraine.

The United States said on Wednesday it had set out a diplomatic path to address sweeping Russian demands in eastern Europe, as Russia held security talks with Western countries and intensified its military build-up near Ukraine.

Global benchmark Brent crude climbed 0.18% to $90.12 per barrel. U.S. West Texas Intermediate crude was little changed at $87.41.

U.S. officials say they are in talks with major energy-producing countries and companies worldwide over a possible diversion of supplies to Europe if Russia invades Ukraine, although the White House said it faces challenges finding alternative sources of energy supplies.

Spot gold weakened 0.5% to $1,809 an ounce, having hit $1,853 earlier in the week.

(Additional reporting by Dhara Ranasinghe in London and Andrew Galbraith in Shanghai; Editing by Robert Birsel and Catherine Evans)

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