Shares Struggle After Wall Street Stumble as Bonds Rally on Rate Cut Hopes

Global stocks slipped on Thursday following a sharp drop on Wall Street the previous day, while bonds rallied strongly amid growing expectations of interest rate cuts next year.

The STOXX Europe 600 index fell 0.4% in early trading, led by declines in auto, tech and travel stocks. However, Commerzbank shares jumped nearly 3% after the European Central Bank approved its 600 million euro stock buyback plan.

Wall Street futures pointed to a modest rebound after the S&P 500 suffered its largest single-day loss since September on Wednesday. There was no major trigger for the selloff, but with the holidays approaching, investors appeared eager to lock in profits from the year’s gains.

The moves in equity and bond markets highlight a dramatic shift in expectations about the economic outlook and central bank policy. Bond yields have staged a stunning round trip after surging earlier this year on bets of aggressive Federal Reserve tightening.

Italy’s 10-year yield fell to its lowest level since August, while the benchmark U.S. 10-year Treasury yield dropped back near 3.9%. The yield was around 5% in October when the Fed was seen staying hawkish for longer to tame high inflation.

Now, markets are betting on inflation having peaked and central banks pivoting to rate cuts as growth slows. Futures imply over 100 basis points of Fed cuts next year with policy seen back near zero by end-2024.

“Everyone expects a soft landing to happen, everyone expects bond yields to be lower and everyone expects Fed rate cuts,” said Bank of America strategist Elyas Galou.

Currencies Fail to Find Direction

In currency markets, the U.S. dollar index was little changed near 104. The dollar also weakened slightly against the Japanese yen, which rallied to 142.50 after Japan raised its economic growth forecasts.

Sterling steadied following its biggest drop in two months on Wednesday when lower-than-expected UK inflation dented bets for further Bank of England tightening.

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The euro also struggled for traction as ECB policymakers sent mixed signals on rate cuts. Vice President Luis de Guindos said rates would only fall once inflation was stably at 2%, but markets still expect easing to begin later in 2023.

Commodities Catch Holiday Spirit Oil prices were largely flat amid light holiday trading volumes. Brent crude held near $80 per barrel, finding support from supply disruption fears even as demand concerns mount.

Prices came under pressure earlier this week after the shutdown of a major pipeline supplying the U.S. Gulf Coast refining hub. Meanwhile, geopolitical risks persist in the Middle East following attacks by Yemen’s Houthis on vessels in the Red Sea.

In Asia, Japan’s Nikkei slid 1.5% from 30-year highs amid broad weakness in technology stocks globally. Chinese shares rebounded over 1% as Beijing vowed stepped up support for the ailing property sector.

Looking Ahead Thursday brings a batch of U.S. economic reports that will shape year-end views on growth as markets enter the holiday lull. The final reading of third quarter GDP is due along with weekly jobless claims and the Chicago Fed national activity index.

The data comes on the heels of improving inflation and retail sales numbers that have lifted hopes of a soft landing. But manufacturing and housing figures indicate still significant headwinds from higher rates.

Meanwhile, Turkey’s central bank may continue its return to orthodoxy by hiking rates another 250 basis points to try taming inflation approaching 100%. The bank has raised rates to 19.75% in recent months after a disastrous experiment with loose policy.

So in summary, stocks and yields may see increased choppiness in thin holiday trading but the broader narrative seems set – peak hawkishness shifting to easing as the world economy slows. With the Fed seen cutting rates next year, the bar for any return to tightening appears extremely high.

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