Wall Street stocks moved sharply lower and yields on short-dated Treasury bonds rose to 14-year highs after fresh evidence of red-hot US inflation drove market fears that the Federal Reserve will be forced to take aggressive monetary action to slow economic growth.
The broad-based S&P 500 stock index fell 2.7 per cent, while the tech-heavy Nasdaq Composite, which is stacked with interest rate-sensitive growth stocks, dropped 3.4 per cent. Both indices were on track for their worst daily performance since May 18.
The yield on the two-year Treasury note, which moves with interest rate expectations, rose to 3 per cent, its highest level since 2008, the last time it passed the psychologically significant 3 per cent level.
The yield on the five-year Treasury briefly surpassed the yield on the 30-year, indicating the market believes that the Fed’s campaign of raising rates could tip the US economy into recession.
The US government’s consumer price index report showed the annual pace of inflation rose to 8.6 per cent in May, above April’s 8.3 per cent reading and exceeding economists’ forecasts as prices of food, energy and shelter all increased.
The Fed is widely expected to raise its main interest rate by a further 0.5 percentage points at its policy meeting next week. At the Fed’s May meeting chair Jay Powell had set the stage for half-point rises in both June and July, but some questions remained about whether the central bank would continue at that pace at it meeting in September. After Friday’s inflation data, the market had fully priced in a 0.5 percentage point rise in September as well.
The futures market now expects the Fed’s benchmark interest rate to be 3.2 per cent by year-end, implying half-point increases at the Fed’s next four meetings — June, July, September and November — plus a quarter-point increase in December.
“The market thinks the Fed is going to have to do more tightening and this increases the risk of recession,” said Brian Nick, chief investment strategist at Nuveen.
Europe’s regional Stoxx 600 share index dropped 2.6 per cent as worries about the US outlook added to fears about the effects of eurozone rate rises on financially weaker European nations.
US and European stocks had also dropped on Thursday when the European Central Bank rattled markets by spelling out its own plans for tightening monetary policy.
The ECB, which has long been one of the world’s most accommodative central banks, signaled on Thursday that it may lift its main deposit rate to above zero in September, which would be its first departure from negative interest rates in eight years. It also said it would end net purchases of member states’ debt, sparking fears about financial stress for the bloc’s weaker economies.
“The message for the markets is that the priority now is quashing inflation, it’s not about growth,” said Paul O’Connor, head of the UK-based multi-asset team at Janus Henderson.
“The ECB’s hawkish pivot,” he added, provided “a big setback for global bulls, as it reinforces the idea that central banks just aren’t going to stop fighting inflation.”
A FTSE index of developed and emerging market shares slipped more than 2.6 per cent, putting it on track for its worst weekly decline since October 2020.
Germany’s 10-year government bond, which serves as a benchmark for borrowing rates in the region, rose 0.07 percentage points to 1.5 per cent, its highest level since 2014.
Italy’s 10-year bond yield rose by 0.15 percentage points to 3.74 per cent, more than triple its level at the start of the year.
In Asia, Hong Kong’s Hang Seng index traded flat and Tokyo’s Nikkei 225 fell 1.5 per cent. Mainland China’s CSI 300 rose 1.5 per cent.