Stocks and Bonds Surge as Investors Overlook Hawkish Fed Minutes

By Koh Gui Qing

NEW YORK (Reuters) – Global stocks and bonds saw gains on Wednesday, driven by cautious optimism as the new year begins following a challenging 2022. However, U.S. stocks retreated from earlier highs after the Federal Reserve released minutes from its December meeting that conveyed a hawkish stance.

The MSCI All-World index increased by 0.65%, pulling back from earlier peaks, mirroring U.S. stocks, which declined after the Fed’s minutes revealed concerns about potential market "misinterpretation" regarding its commitment to combating inflation.

Citi analysts described the minutes as "modestly hawkish" and anticipated a 50 basis point rate hike from the Fed in February, with U.S. rates expected to peak between 5.25% and 5.5%. Currently, U.S. rates are set between 4.25% and 4.5%.

"Fed officials appear increasingly uneasy about the market underestimating their likely policy path and may adopt more hawkish language to elevate front-end rates and tighten financial conditions," the analysts stated.

Despite the pullback, U.S. stocks remained positive for the day, with the S&P 500 rising by 0.75%, the Dow Jones Industrial Average increasing by 0.4%, and the Nasdaq Composite gaining 0.7%.

Data released on Wednesday indicated that U.S. job openings fell less than expected at the end of November, suggesting a still-tight labor market that could allow the Fed to maintain higher rates for a more extended period.

In Europe, markets responded positively, with the pan-European Stoxx 600 index jumping 1.4%, as a lower inflation reading from France bolstered sentiment, building on encouraging data from Germany earlier in the week.

Euro zone government bonds continued their rally from the start of the year, with benchmark German 10-year yields dipping around 10 basis points, indicating progress by central banks against inflation.

In the U.S., the yield on the 10-year Treasury fell to 3.679%, while 2-year Treasury yields, which closely align with interest rate expectations, dipped to 4.3534%.

MSCI’s broadest index of Asia-Pacific shares outside Japan rose by 1.8%, marking its third consecutive day of gains in the new year. In 2022, this index experienced a 20% decline, its largest annual drop since 2008.

The modest recovery in stocks and bonds reflects optimism about overcoming two major challenges that plagued investors in 2022: relentless rate hikes aimed at addressing inflation and China’s stringent COVID-19 measures that hampered economic activity.

However, investors in other asset classes showed signs of anxiety. Oil prices fell sharply due to lingering concerns about global demand, compounded by indications of weakening economic activity in major growth regions such as the United States, Europe, and China.

"New warnings regarding the impact of aggressive rate hikes on the U.S. economy are unsettling traders again, leading to a continued decline in oil prices," noted Susannah Streeter, a senior investment and markets analyst at Hargreaves Lansdown.

West Texas Intermediate crude fell 4.85% to $73.2 per barrel, while Brent crude slid 4.9% to $78.07.

The market has taken a tentative start this year, still grappling with expectations regarding the Fed’s future actions, according to Rob Carnell, head of ING’s Asia-Pacific research.

"There are two prevailing perspectives, each vying for influence. On some days, the ‘higher-for-longer’ view prevails, while on others, the ‘higher-then-lower’ camp takes the lead," Carnell explained.

Expectations for less aggressive rate hikes provided a boost to non-yielding gold, with spot prices for the metal reaching $1,856.57 per ounce, the highest level since mid-June.

The dollar index, which measures the U.S. currency against six others, declined by 0.45% as commodity-related currencies like the Australian dollar strengthened, and the euro rose in response to favorable inflation data from France and Germany.

The British pound was last trading at $1.20575, up 0.75%, while the euro gained 0.54% to $1.06050, recovering from a three-week low of $1.0519. The Japanese yen weakened against the dollar, trading at 132.500 per dollar.