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Stocks and bonds under pressure as the market price in the larger US rate rises

Stocks dropped, government bonds sold off and the dollar ripped higher on Thursday, as red-hot inflation in the world’s largest economy fueled expectations of larger US interest rate rises.

Europe’s Stoxx 600 share gauge dropped 0.9 percent, taking its year-to-date losses to 16 percent. Futures contracts tracking Wall Street’s S&P 500 fell 1.3 percent, after the broad index closed 0.5 percent lower on Wednesday, while contracts tracking the technology-heavy Nasdaq 100 slumped 1.1 percent.

US consumer prices increased by their most in 40 years last month, a report from the Bureau of Labor Statistics showed on Wednesday, with the annual rate of inflation topping economists’ forecasts to hit 9.1 percent.

Those data fueled expectations of a much larger interest rate rise from the US Federal Reserve when it meets at the end of July. Futures markets are now pricing the possibility of a 1 percentage point increase by the Fed, after it raised borrowing costs by 0.75 percentage points in June — the most since 1994.

Salman Ahmed, global head of macro and strategic allocation at Fidelity International, said a 0.75 percentage point rise “looks very likely” but added that the market was continuing to price a peak interest rate of 3.5 per cent, with the Fed simply “frontloading hikes “.

“This is not just about inflation,” he said. “There’s a significant slowdown in the pipeline. We think this growth slowdown will turn into a recession.”

Fed chair Jay Powell has previously emphasized the central bank’s “unconditional” approach to bringing down inflation, even if this prompts a recession.

The prospect of more aggressive monetary policy tightening by the Fed piled pressure on government bonds, with the yield on the 10-year US Treasury note adding 0.07 percentage points to 2.97 percent. The two-year yield, which closely tracks interest rate expectations, also added 0.07 percentage points, to 3.21 percent. Bond yields rise when their prices fall.

Those moves meant that the so-called Treasury yield curve remained at its most inverted in more than 20 years, a scenario that has historically preceded recession in the world’s largest economy.

Eurozone debt was also beaten down, with the two-year German bond yield adding 0.13 percentage points to 0.58 per cent and Italy’s equivalent yield surging 0.2 percentage points to 1.28 per cent.

Analysts were divided over the extent to which the Fed will raise rates. Ajay Rajadhyaksha, an analyst at Barclays, revised his expectations of Fed rate rises from a 0.5 to 0.75 percentage point rise following the scorching CPI data.

“There is no way to sugarcoat it — this was a troublesome inflation report,” he wrote. “[But] we believe that [1.6 percentage point rises over the next two meetings] is too aggressive a hiking path and unlikely to be realized.”

Anticipation of higher US borrowing costs and the possibility of a global economic slowdown drove investors into the dollar, traditionally seen as a haven in times of stress. The dollar index, which measures the US currency against a basket of six others, rose 0.2 percent.

That gain spelled further pain for the euro, which on Wednesday briefly weakened to parity with the greenback for the first time in 20 years. The common currency slipped 0.3 percent on Thursday to trade a fraction above $1.

The Japanese yen lost more than 1 per cent to hit a fresh 24-year low of ¥139.39 as traders bet that the Bank of Japan would stick to its ultra-loose monetary policy, marking an increasingly stark divergence from the strategies of other major central banks as they attempt to stamp on rapid price growth.

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