Stocks hit two-year lows, sterling comes under fire

Global shares sank to two-year lows on Wednesday as surging borrowing costs and a worsening energy crisis intensified fears that the world could tip into recession, which sent investors dashing for the safe-haven dollar.

Yields on US 10-year Treasuries topped 4.0 per cent for the first time since 2010 as markets wagered the Federal Reserve might have to take interest rates past 4.5 per cent in its crusade against inflation.

The pound came under fire again on the back of a renewed surge in UK bond yields that have driven the government's borrowing costs above those with heavier debt burdens such as Greece or Italy.

The International Monetary Fund (IMF) and ratings agency Moody's criticised Britain's new economic strategy announced on Friday, which has sparked a collapse in the value of British assets. Investors braced for more havoc in bond markets that has already forced the Bank of England to promise "significant" action.

Central banks around the world have jacked up interest rates in the last week and said they would do whatever it takes to fight red-hot inflation, particularly as the northern hemisphere winter risks exacerbating a global energy crunch.

"Inflation has surprised to the upside everywhere and US dollar strength is becoming a headache for global central banks," said Ugo Lancioni, head of global currency at Neuberger Berman.

The dominance of the dollar this year has compounded the problem, adding billions to the food and energy import bills for everyone, bar the United States.

"The energy supply shock has prompted a terms-of-trade crisis for all energy importing countries. The U.S. dollar is probably entering an 'overshooting' phase driven by risk aversion, lower global growth and higher US real rates," he said.

The MSCI All-World index fell 0.7 per cent, dropping for a seventh day in a row, to hit its lowest since November 2020. It is heading for a 9 per cent drop in September - its biggest monthly decline since March 2020's 13 per cent fall.

In Europe, the STOXX 600 lost 1.8 per cent, with every sector except healthcare - often seen by investors as a port in a storm - in the red. Across the region, the export-sensitive DAX <.GDAXI > fell 2.1 per cent to its lowest since late 2020, while the FTSE 100 fell nearly 2 per cent, and the domestically focussed FTSE 250 lost almost 3 per cent.

Wall Street looked set for a weak open, as S&P 500 futures fell 1.1 per cent, while Nasdaq futures lost 1.5 per cent.

European government bonds came under pressure again as the region's energy crisis intensified following a series of incidents that caused leaks on the Nord Stream gas pipeline.

Germany's 10-year government bond yield rose 5 basis points (bps) to 2.3 per cent after hitting a near 11-year high at 2.309 per cent.

"European sovereign yields have soared to multi-year highs amid concerns about UK policy-making and a right-ward shift of Italian politics in the midst of still elevated inflation," wrote analysts at JPMorgan in a note.

"The Italian 10-year spread to the German Bund has eclipsed 250bp, well above the 200bp mark we believe makes the ECB uncomfortable."

European benchmark natural gas prices are 150 per cent higher now than they were this time last year.

More risk premium, please

At the heart of this most recent sell-off across global markets was the British government's so-called "mini-budget" last week that announced a raft of tax cuts and little in the way of detail as to how those would be funded.

Gilt prices have plunged and the pound has hit record lows as a result.

Ray Dalio, the founder of Bridgewater Associates, one of the world's largest hedge funds, said the government's plan to sell billions more in UK debt to fund its tax cuts was the icing on the cake.

"The panic selling you are now seeing that is leading to the plunge of UK bonds, currency, and financial assets is due to the recognition that the big supply of debt that will have to be sold by the government is much too much for the demand," Dalio tweeted on Tuesday.

"That makes people want to get out of the debt and currency. I can't understand how those who were behind this move didn't understand that. It suggests incompetence. Mechanistically, the UK government is operating like the government of an emerging country," he said.

Sterling fell 0.6 per cent to $1.0675, still above Monday's record trough of $1.0327 but set for its biggest monthly slide since the Brexit vote in June 2016.

The safe-haven dollar has been a major beneficiary from the rout in sterling, rising to a fresh 20-year peak of 114.780 against a basket of currencies.

The euro fell for a sixth straight day, dropping 0.4 per cent to $0.95505 narrowly off last week's 20-year low of $0.9528.

Oil prices fell to their lowest since the start of the year, dented by concern over demand if the world economy slows, although US production cuts caused by Hurricane Ian helped stem the slide.

Brent was last down 0.3 per cent at $86.02 a barrel, while US crude dropped 0.5 per cent to $78.17 a barrel.