US bonds and equities soften ahead of Fed meeting

US government bond prices softened and Wall Street stocks failed to build on all-time highs reached last week as traders turned cautious ahead of a two-day US central bank meeting that begins on Tuesday.

After a rally last week as investors banked on the Federal Reserve looking past high US inflation to maintain its pandemic-era support for financial markets, the yield on the benchmark 10-year Treasury bond rose 0.02 percentage points to 1.485 per cent.

Wall Street’s S&P 500 share index drifted 0.3 per cent lower in early New York dealings after hitting another record high on Friday. The technology-focused Nasdaq Composite index rose 0.1 per cent. The Stoxx Europe 600 also gained 0.1 per cent, on course to eke out a new closing high.

The Fed is widely expected to maintain its $120bn of monthly bond purchases that have eased financial conditions for companies and households since March last year.

These asset purchases, which have been followed by rate-setters in Europe and the UK, have lowered the yields on government bonds, reducing corporate borrowing costs and boosting the appeal of riskier assets such as equities.

However, after a rapid recovery of the US economy fuelled by coronavirus vaccines and President Joe Biden’s massive stimulus programmes, some analysts see the Fed’s policymakers bringing forward their predictions of the first post-pandemic interest rate rise.

“We expect the Fed to upgrade its outlook for growth and materially revise up the inflation forecast,” Tiffany Wilding, US economist at bond investment house Pimco, said in a research note. “We think the majority of Fed officials will also pull forward their projections for the first rate hike to 2023 [from 2024].”

Fed vice-chair Richard Clarida last month called for a debate about reducing the central bank’s asset purchases as the US recovery accelerated.

“We are expecting more talk of a future discussion about tapering,” said Grace Peters, investment strategist at JPMorgan’s private bank. “With the actual taper to start at the beginning of next year.”

The FTSE All-World index of developed and emerging market shares has hovered around its all-time high for weeks as investors take a wait-and-see approach on the longer term path of monetary policy.

Headline US consumer price inflation hit 5 per cent in the 12 months to May. Jay Powell, Fed chair, has maintained that the rises are a temporary effect of the US economy reopening after coronavirus shutdowns. “But others are concerned inflation is more structural,” said Marco Pirondini, head of US equities at Amundi. “I’d say it is 50-50 on either side.”

A rise in used car and truck prices, after a global semiconductor shortage lowered production of new vehicles, accounted for about a third of the increase in May’s CPI, according to the Bureau of Labor Statistics.

But US wages could also “go up in a more sustained way”, Pirondini said, after Biden signed an executive order in late April to increase government pay, pressuring private industry to also raise salaries.

The dollar index, which measures the US currency against those of trading partners, dipped 0.1 per cent. The euro was up 0.2 per cent against the dollar, purchasing $1.212. Sterling was up 0.1 per cent at $1.411. The dollar index has gained 0.7 per cent this year, with currency traders also waiting for a clearer picture of the future path of US monetary policy.

Brent crude, the international oil benchmark, gained 1 per cent to $73.39 a barrel.

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