Stocks rallied as bond markets regained rate expectations

LONDON, June 8 (Reuters) – Borrowing costs in government bond markets rose and stock markets rallied on Thursday after a surprise interest rate hike in Canada gave investors a second reminder of the week that the rise in global interest rates is not done yet.

Asian markets struggled overnight and a cautious mood continued in Europe, with London’s FTSE (.FTSE), Germany’s DAX (.GADXI) and France’s CAC40 (.FCHI) rising steadily after starting in the red.

Traders are being driven by a broad reassessment in bond markets of when and where interest rates will peak in the world’s biggest economies.

In an almost carbon copy of a surprise rate hike in Australia this week, Canada did not spare markets by raising its interest rates to a 22-year high of 4.75% amid an overheated economy and stubbornly high inflation.

US 10-year Treasury yields, a gauge of global borrowing costs, returned above 3.8%, while in Europe Germany’s 2-year yield rose to 3% for the first time since March, albeit briefly.

“The main theme for everything out there is bond selling and a pause (in central banks’ rate hike cycles) doesn’t mean the end,” said Societe Generale strategist Kit Jukes.

“We are certainly revising rate expectations higher,” he added, adding that traders are now questioning the long-held view that the US Federal Reserve will end its rate hike cycle before the European Central Bank.

The Fed, ECB and Bank of Japan have interest rate decisions next week.

Tapas Strickland, NAB’s head of market economics, said steps from the BoC and RBA meant Tuesday’s US inflation data meant the central bank would hike this month or avoid a widely expected move.

The dollar fell slightly on Thursday but was near a three-month high following gains of more than 2.5% against other major world currencies in the past month.

Markets are now pricing in a 64% chance of the Fed standing pat next week, compared with 78% a day earlier, the CME FedWatch tool showed. Traders are widely expecting a 25 basis point hike in July.

“The view here is that if both Australia and Canada feel the need for further hikes, then in all probability the central bank will as well,” said Chris Turner, head of markets at ING.

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Overnight in Asia, both Chinese shares (.SSEC) and Hong Kong’s Hang Seng Index (.HSI) fell again, still feeling the effects of Wednesday’s slide in export data — a 7.5% year-on-year drop and the biggest drop since January.

“Weak export numbers will have observers looking for a fresh round of policy stimulus,” Saxo Markets strategists said.

The yen strengthened 0.2% to 139.80 per dollar after showing that Japan’s economy grew more than initially thought in January-March.

The dollar index, which measures the U.S. currency against six major peers, was down 0.1% in European trade. The euro rose 0.15% to $1.0717, while the Canadian dollar consolidated gains after the BoC’s surprise hike.

Among commodities, U.S. crude was down 0.25% at $72.37 a barrel, while Brent was down 0.25% at $76.76.

Gold prices were steady after a 1% decline in the previous session, with spot gold up 0.3% at $1,945.89 an ounce.

Among emerging markets, Turkey’s lira, another record low. The lira saw a 7% drop on Wednesday, signs that Tayyip Erdogan’s newly re-elected government is abandoning an 18-month strategy of keeping the currency on a tight leash.

“The point is that it (the lira) was artificially stable for so long before the elections,” said SEB’s chief emerging market strategist Eric Meyerson, who also pointed to ongoing questions over Turkey’s economic policies.

Additional reporting by Ankur Banerjee in Singapore; Editing by Toby Chopra

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