US yields rise, Asian shares slump as Fed Chair Powell warns on inflation

The Federal Reserve has indicated it is likely to raise U.S. interest rates in March, as has been widely expected

Asian shares tumbled to their lowest in nearly 15 months, short-term U.S. yields rose to 23-month highs and the dollar strengthened on Thursday after the Federal Reserve's chairman signalled plans to steadily tighten policy. At the same time, rising investor concerns over political tensions between Russia and Ukraine exacerbated worries over tight energy market supply, keeping oil prices elevated at multi-year highs despite some profit-taking.

In its latest policy update on Wednesday, the Fed indicated it is likely to raise U.S. interest rates in March, as has been widely expected, and reaffirmed plans to end its bond purchases that month before launching a significant reduction in its asset holdings. But in the follow-up press conference, Powell warned that inflation remains above the Fed's long-run goal and supply chain issues may be more persistent than previously thought.

"There was a marked shift in terms of a relatively dovish statement and then a relatively hawkish press conference," said David Chao, global market strategist, Asia Pacific (ex-Japan) at Invesco. "Powell (is) not committing to the size or the frequency of rate hikes and also the timing of the balance sheet reduction. I think that buys him a bit of wiggle room as to how quickly and with what velocity he wants to normalise monetary policy in the U.S. ... it's very data dependent and so we're certainly watching other economic data that's going to be released especially inflation data, inflation expectations data, which I think could trigger more aggressive monetary policy tightening." Fed funds futures showed traders pricing in as many as five hikes by December, after previously fully pricing for four increases.

Concerns that the Fed will increasingly prioritise fighting inflation walloped share markets. MSCI's broad gauge of regional markets outside Japan fell more than 2% on Thursday to its lowest level since Nov. 5, 2020. Hong Kong's Hang Seng index and Australian shares fell more than 2% and Chinese blue-chips dropped to their lowest level since Sept. 30, 2020 as Refinitiv flows data pointed to heavy selling by foreign investors through the country's Stock Connect scheme. In Tokyo, the Nikkei fell more than 2.5%, touching its lowest point since Nov. 26, 2020.

The drop echoed a sharp reversal in U.S. shares overnight. The S&P 500 closed 0.14% lower following Powell's comments after earlier rising more than 2%, and the Nasdaq Composite finished barely higher, erasing a rise of more than 3.4%.

The policy-sensitive U.S. 2-year yield jumped amid expectations of Fed tightening, rising to a top of 1.1920% in morning trade in Asia, a level last reached in February 2020. The benchmark 10-year yield also ticked up from Wednesday's close, rising to 1.8566% from 1.846%. The dollar rose on the back of higher yields, lifting the U.S. dollar index, which measures the greenback against major peers, to 96.604, near five-week highs.

The yen was flat at 114.63, while the euro weakened 0.1% to $1.1225.

"The interesting play seems to be that yield differentials matter again, so we've got a decent set-up on dollar-yen. If you look at the yield differential between the 2-year on the U.S. and the Japanese, it's just shot up," said Matt Simpson, senior market analyst at City Index in Sydney.

The spread between the U.S. and Japanese 2-year yield widened to 124.22 basis points on Thursday, its highest since late February 2020.

In commodities markets, oil prices eased but remained elevated near $90 per barrel, a level last seen in October 2014, on festering tensions between Russia and Ukraine.

The United States said on Wednesday it had set out a diplomatic path to address sweeping Russian demands in eastern Europe, as Moscow held security talks with Western countries and intensified its military build-up near Ukraine with new drills.

On Thursday, global benchmark Brent crude fell 0.64% on profit taking to $89.38 per barrel. U.S. West Texas Intermediate crude was down 0.6% at $86.83 per barrel.

U.S. officials say they are in talks with major energy-producing countries and companies worldwide over a potential diversion of supplies to Europe if Russia invades Ukraine, although the White House said it faces challenges finding alternative sources of energy supplies.

Spot gold slipped 0.12% to $1,815.88 an ounce.

"When you see gold falling with stocks it's usually a signal that things aren't so well, but you can really tie everything back to the Fed raising rates, the dollar screaming higher with the yields, everything else is going the opposite way," said Simpson at City Index.

(Reporting by Andrew Galbraith; editing by Richard Pullin)