Stocks rally fizzles, bond markets ponder risks for US economy

Highlights:

• Euro STOXX 600 falls 0.6%
• US bond market signals economic pain ahead
• Treasury 10-year yields lower
• Ukraine-Russia negotiations earlier buoyed stocks
• Wall Street down

The US and European equities rally wavered on Wednesday as investors reviewed economic and geopolitical risks, while oil prices jumped more than $2 on the prospect of more Russian sanctions.

The breather in stocks followed three to four straight days of gains that more than erased losses sustained when Russia invaded Ukraine five weeks ago, and came as bond investors wondered whether the US Federal Reserve's policy tightening could harm the world's biggest economy over the longer term.

A key part of the US yield curve briefly inverted on Tuesday in what is widely viewed as a harbinger of a recession, although it has since reverted.

"We see further equity upside medium-term given a robust growth picture, low bar for first-quarter earnings, and narrowing credit spreads," analysts at JP Morgan's Global Markets Strategy said.

"We see too much negativity around the Fed since the start of Fed tightening cycles proved positive for equities historically, and policy is easing in Japan and China."

The Dow Jones Industrial Average (.DJI) ended down 0.19%, the S&P 500 (.SPX) fell 0.63%, and the Nasdaq Composite (.IXIC) shed 1.2%.

Europe's broad Euro STOXX 600 (.STOXX) lost 0.4%, while the MSCI world equity index (.MIWD00000PUS), which tracks shares in 50 countries, eased 0.32%.

The widely tracked yield curve showing the difference between two- and 10-year US Treasury yields bounced back to 4 basis points on Wednesday. It had briefly inverted to minus 0.03 of a basis point on Tuesday for the first time since September 2019.

Longer-dated yields falling below shorter ones indicate a lack of faith in future growth. A drop in 10-year yields below 2-year rates signals a recession.

Sebastien Galy, a senior macro strategist at Nordea Asset Management, said fixed income and equity markets are diverging in their outlooks and the split bears watching.

"Equity markets are overly optimistic and the fixed income markets are probably being overly pessimistic."

An inverted Treasury curve has in recent decades been followed by a recession within two years, including the 2020 downturn caused by the Covid-19 pandemic.

Benchmark indexes in Frankfurt (.GDAXI) and Paris (.FCHI) lost 1.5% and 0.74% respectively, while London shares (.FTSE) bucked the trend and jumped 0.55%.

A day after rising above 0% for the first time since 2014, Germany's two-year bond yield was up 6 basis points at 0.01% - keeping the previous day's highs in sight.

Shares rallied in Asia overnight after Ukraine proposed on Tuesday that it adopt neutral status, a sign of progress in face-to-face peace talks. read more

On the ground, attacks continued and Ukraine reacted with scepticism to Russia's promise in negotiations to scale down military operations around Kyiv.

MSCI's broadest index of Asia-Pacific shares outside Japan (.MIAPJ0000PUS) jumped 1.36% to its highest level in nearly a month, with most Asian stock markets in positive territory.

JAPAN IN FOCUS

The benchmark US 10-year yield was last at 2.3415% , after rising to 2.557% on Monday, its highest level since April 2019, as traders geared up for quick-fire US interest rate hikes.

Rising US yields have also lifted government bond yields in Japan, where inflation is running below target and where the central bank wants yields to stay low.

The Bank of Japan increased efforts to defend its key yield cap on Wednesday, offering to ramp up buying of government bonds across the curve, including unscheduled emergency market operations. read more

The widening gap between US and Japanese yields has caused the yen to weaken sharply, but it pared losses on Wednesday.

The Japanese currency rose 0.9% to 121.81 per dollar from Monday's low of 124.3, amid concerns Japanese authorities might step in to bolster the yen.

Elsewhere in currency markets, the euro rose 0.6% to $1.1156, its highest in four weeks, supported by the Russia-Ukraine peace talks.

In commodities, oil prices jumped more than $2 on supply tightness and the growing prospect of new Western sanctions against Russia even as Moscow and Kyiv held peace talks.

Brent crude futures were up $2.28, or 2.1%, at $112.51, while US crude rose 2.9% to $107.3 per barrel.

Spot gold added 0.8% to $1,935.38 an ounce.