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Global Markets: Stocks, bonds rally as investors spy possible central bank ‘pivot’; pound

In Europe, benchmark natural gas prices, which have served as a proxy for inflation, fell to their lowest in two months, which could take some pressure off the European Central Bank.

Global Markets: Stocks, bonds rally as investors spy possible central bank ‘pivot’; pound
Markets show investors believe inflation is likely to drop more quickly. (IE)

Global stocks and bond prices rallied on Tuesday, buoyed by a growing belief among investors that central banks may be on the verge of shifting down a gear in their quest to fight inflation, while UK assets benefitted from a government U-turn on tax cuts.

A number of factors have helped douse some of the expectations for policymakers to deliver hefty rate hike after rate hike to quell inflation.

A weaker read of U.S. manufacturing data for September, coupled with a retreat in eye-wateringly high European energy prices, and a smaller rate rise by the Australian central bank helped push down borrowing costs around the globe and plumped up investor appetite for risk.

With borrowing costs having surged in the last couple of weeks in particular, a number of companies, including Swiss lender Credit Suisse, have found themselves in the line of fire.

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“The sight of a bond rally when investors smell a whiff of a central bank pivot is something to behold,” ING strategists led by Padraig Garvey said.

“The root cause of the recent re-pricing lower in rates can be traced back to two factors: the global economic slowdown and resurgent fears for financial stability.”

The MSCI All-World index was last up 0.9% on the day, while stocks in Europe headed for their biggest one-day rally in over three months, as the Stoxx 600 traded 2.6% higher and London’s FTSE gained 1.8%.

The pound, meanwhile, rose 0.1% against the dollar to trade at $1.1363, having pared some of the day’s gains. Sterling has risen by more than 10% since the mini-budget unveiled by Finance Minister Kwasi Kwarteng last week triggered alarm across the financial markets.

Global bond yields headed lower, with those on the benchmark U.S. 10-year Treasury note falling 6 basis points to 3.587%. The yield fell by nearly 20 basis points on Monday, having topped 4.0% just last week.

“Noticeably, that move lower was entirely driven by a fall in real yields, with inflation breakevens moving higher on the day, which is again a sign that investors are pricing in a much less aggressive reaction from the Fed,” Deutsche Bank strategist Jim Reid said in a daily note.

DOLLAR RELAXES ITS GRIP

With Treasury yields falling, the dollar was on course for a fifth consecutive daily loss against a basket of currencies – its longest streak of declines since August 2021 – as investors began to price in the possibility that tighter credit conditions will make the Federal Reserve tread more carefully.

However, some analysts said this optimism may be misplaced.

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“My firm view, however, is that this will not be the case. While, technically, having a dual mandate, the Fed have effectively become a single-issue central bank; that issue being bringing inflation back to the 2% target,” Michael Brown, chief strategist at CaxtonFX, said.

“Unless we see a few months of consecutive improvement in inflation data, it’s tough to envisage any sort of pivot, with another 75 bps hike remaining my base case for next month’s decision. It’s tough to be long risk with that on the radar.”

Markets show investors believe inflation is likely to drop more quickly. On a five-year horizon, investors see inflation at just 2.24%, down from nearer 3% six weeks ago.

In Europe, benchmark natural gas prices, which have served as a proxy for inflation, fell to their lowest in two months, which could take some pressure off the European Central Bank.

In the UK, Kwarteng on Monday announced the government would back down on a tax cut for top earners that formed part of a package aimed at boosting growth.

This measure only makes up a small part of the 45 billion pounds ($51 billion) in unfunded tax cuts, but it was enough to soothe some of the recent angst in the market and, together with emergency bond buying from the Bank of England, sterling was set to make up most of the losses incurred since the mini budget was unveiled on Sept. 23.

But the respite seen across the markets on Monday and Tuesday would likely not last, given the bleak outlook for the British economy, analysts said.

“The about-face … will not have a huge impact on the overall UK fiscal situation in our view,” said NatWest Markets’ head of economics and markets strategy John Briggs.

“(But) investors took it as a signal that the UK government could and is at least partially willing to walk back from its intentions that so disrupted markets over the past week.”

S&P 500 futures rose 1.8%, following a 2.6% bounce for the index overnight, suggesting a second day of gains may be in the offing on Wall Street later.

Oil rallied for a second day, boosted by the prospect of output cuts from the world’s biggest exporters, leaving Brent futures up 1.1% at $89.84 a barrel.

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