The dollar rose and government bonds rallied on Monday, while stocks fell, as traders weighed the possibility of further aggressive US interest rate hikes and intensifying recession risks in Europe.
The dollar index, which tracks the US currency against six others and is heavily weighted in the euro, rose 1 percent to a new 20-year high. That rally helped push the euro closer to parity with the dollar, with Europe’s common currency down as much as 1.3 percent to $1.0051 — approaching a milestone not seen in nearly two decades.
The Japanese yen also fell to a new 24-year low against the dollar at ¥137.75.
Market sentiment in recent weeks has fluctuated between acknowledgment that central banks must raise interest rates aggressively to combat rising inflation and a more optimistic view that excessive monetary policy tightening could cause the global economy to slow.
Both narratives have strengthened investor sentiment towards the dollar, especially as recession risks are perceived to be higher in Europe. The European Central Bank has followed the US Federal Reserve in tightening monetary policy, but is expected to remain as tight as possible to counter economic shocks from Russia’s invasion of Ukraine.
“We expect a recession earlier in Europe,” said Sonja Laud, chief investment officer at Legal & General Investment Management. “The US is an energy exporter, Europe is an importer and in the current energy price environment that makes a difference.”
After unexpectedly strong employment data for June, analysts expect the Fed to raise rates by as much as 0.75 percentage points at its July meeting to tame inflation, following a similar move last month.
Still, investors have scaled back their expectations for the extent to which the Fed will raise borrowing costs in the coming months, with futures markets now pricing in a benchmark rate of 3.5 percent for early 2023 — down from expectations of a 3, 9 percent in mid-June. The Fed’s current range is 1.5-1.75 percent.
Expectations about how far the ECB will raise borrowing costs have also eased in recent weeks, with the market pricing in a rate of just over 1 percent through February, from a current level of minus 0.5 percent.
The Bank of Japan, meanwhile, defied the global trend of tighter monetary policy. On Monday, BoJ Governor Haruhiko Kuroda warned of “very high uncertainty” for the domestic economy in a strong signal that the central bank will maintain its accommodative stance.
Government debt markets rallied on Monday, with the yield on 10-year US Treasuries falling 0.12 percentage points to 2.98 percent. The policy-sensitive two-year yield slipped 0.07 percent lower to 3.05 percent, remaining higher than its longer-dated counterpart in the ‘inversion’ scenario that has preceded every US recession in the past 50 years. Bond yields fall as their prices rise.
Germany’s benchmark 10-year Bund yield fell 0.1 percentage point to 1.248 percent.
In stock markets, Wall Street’s S&P 500 index, which rose last week after its worst first half of the year in more than five decades, was down 1 percent by early afternoon in New York. The tech-heavy Nasdaq Composite fell 1.9 percent.
Europe’s Stoxx 600 fell 0.5 percent, after a sharp drop in China fueled by new Covid-19 restrictions.
Hong Kong’s Hang Seng stock index fell 2.8 percent and China’s CSI 300 fell 1.7 percent after cities across China reimposed coronavirus restrictions to combat the highly contagious BA.5 Omicron sub-variant.