Rising bond yields keep world stocks on shaky ground

By Dhara Ranasinghe

LONDON (Reuters) - World stock markets remained on shaky ground on Thursday as U.S. bond yields crept back towards four-year highs after congressional leaders reached a two-year budget deal to raise government spending by almost $300 billion.

While the deal was a rare display of bipartisanship that should stave off a government shutdown, it looks set to widen the U.S. federal deficit further and could fan inflation, prompting the Federal Reserve to lift interest rates faster.

Euro zone yields were also higher on the day while a hawkish message from the Bank of England on interest rates, pushed UK stocks down around 1 percent and lifted yields on UK government bonds to the highest since 2015.

 

All that is keeping equities on tenterhooks.

While MSCI's world index has risen off two-month lows hit earlier this week, the tentative rebound from Wednesday's has fizzled. That pushed the index some 0.2 percent lower <.MIWD00000PUS> while European bourses were weighed down by commodity and technology stocks.

The pan-European STOXX 600 share index <.STOXX> fell 0.5 percent, and is still down almost 3 percent year-to-date.

Wall Street too looks set for a weaker session, with U.S. stock futures <1YMc1>, down around a quarter percent, as investors eye the potential for higher inflation and borrowing costs.

That has "toned down the straight line move on equity markets, led to a more volatile environment and limited the potential for equities," Francois Savary, chief investment officer at wealth manager Prime Partners said, referring to investors' bullishness prior to the recent correction.

"I don't think markets can recover immediately (from the shock), there needs to be a stabilisation phase".

The previous two sessions saw the heaviest volumes traded on the STOXX 600 index in more than seven months.

Volumes on U.S. exchanges meanwhile exceeded 9 billion shares for a fourth straight day on Wednesday, a figure surpassed just once before in the past seven months, according to Deutsche Bank.

In Asia, MSCI's index of emerging Asian equities <.MIAPJ0000PUS> remained near six-week lows.

Focus was on China, where Shanghai's benchmark index hit a six-month low <.SSEC> after Beijing resumed an outbound investment scheme after a two-year hiatus, granting licenses to about a dozen global money managers, sources said.

SPENDING SOARS

The recent selloff, sparked by last Friday's jump in Treasury yields, sent the VIX index <.VIX>, considered Wall Street's "fear gauge", spiralling. The index is down just below 30 on Thursday, but that is more than twice the levels seen in the past few months.

Bond yields got a fresh impetus on Wednesday from U.S., lawmakers' deal on the budget, with 10-year U.S. yields back > up to 2.84 percent, near Monday's four-year peak of 2.885 percent.

The fear now is that alongside the economic boost President Donald Trump's tax cut plans may deliver, higher deficit spending could overheat the already strong U.S. economy and accelerate inflation to levels not seen in over a decade.

The Senate and the House were both expected to vote on the deal on Thursday.

"The news yesterday has set up a test for 3 percent on 10-year Treasury yields," Savary said.

European bond yields > also rose, lifted by the prospect of increased fiscal spending after Wednesday's coalition government deal in Germany.

UK government bond yields rose too after the Bank of England said interest rates probably needed to rise sooner and by a bit more than it thought three months ago and raised economic growth forecasts for Britain.

British two-year government bond yields > rose to the highest since December 2015 after the statement, rising around 6 basis points to 0.706 percent. Sterling rose around one percent against the dollar and euro > >.

(Additional reporting by Hideyuki Sano in Tokyo and Sujata Rao in London; Editing by Kevin Liffey and Janet Lawrence)