China leads world stocks in attempt to scale Fed, trade war hurdles

By Sujata Rao

LONDON (Reuters) - A Chinese equity bounce set a modestly positive tone for world stocks on Wednesday as bets that Beijing would expand stimulus to support its economy helped offset some of the worries about global trade tensions and $80-a-barrel oil.

World stocks were flat, not far off six-month highs, but sentiment remains in check with U.S. benchmark bond yields close to seven-year peaks, and as investors weigh how much more policy tightening is in store from the U.S. Federal Reserve.

European shares trod water, failing to extend gains seen in Asia where Shanghai-listed shares closed almost one percent higher at eight-week highs. However, Wall Street looked set for a firmer session, with futures for all three New York indices up around 0.2 percent.

Chinese shares rose after global index provider MSCI said it could quadruple China's weighting in global benchmarks, lending fresh impetus to a market already buoyed by expectations of state stimulus to offset the impact of U.S. tariffs.

Beijing is not expected to follow the U.S. Federal Reserve in raising interest rates this week.

"The Chinese over the summer increased monetary stimulus for the system and may do more, though their ability going forward is going to be limited," said Francois Savary, chief investment officer at wealth manager Prime Partners.

Savary said markets had also been heartened by the U.S. decision to impose tariffs on China at a lower 10 percent rate that the 25 percent originally threatened. Recent data point to strong U.S. economic momentum, despite concerns about the trade wars U.S. President Donald Trump is waging.

"You have economic numbers that are satisfactory... so people feel for the time being, at least, the impact on economic activity from the trade war may not be very substantial," he added

A pan-European equity index failed to build on the previous session's gains though it remains close to one-month highs. World shares too struggled to make headway with investors keeping close watch on bond yields in the United States and Germany.

In the latest hurdle for equity markets, ten-year borrowing costs in both countries have inched to multi-month highs, with the first interest rate rise by the European Central Bank now expected in September 2019, two months earlier than had been priced recently.

German bonds, where many investors have taken shelter due to uncertainty in Italian markets, could see yields rise as the Italian coalition government has signalled repeatedly in recent days that its budget statement due on Thursday will not set out a spending binge. Italian yields fell as much as 10 bps on the day.

U.S. 10-year Treasury yields traded around 3.08 percent, having risen as high as 3.113 percent on Tuesday, approaching a seven-year peak of 3.128 percent hit on May 18.

Fed funds rates futures implied traders are fully pricing in a U.S. rate hike on Wednesday, plus an 85 percent chance of another rise in December. That expectation was cemented after data showed U.S. consumer confidence hit an 18-year high.

"The focus will be on whether the Fed will indicate its tightening is coming to an end. The Fed may not do so today but I expect markets will soon start looking to that scenario," said Akira Takei, bond fund manager at Asset Management One.

The Fed's past policy statements have shown that policy makers see 2.9 percent, about 100 basis points above the current levels, as an appropriate level in the longer run.

The Fed could hit that level by the end of next year if, as expected, it hikes on Wednesday, again in December and then twice more in 2019.

Takei noted signs that higher rates are already starting to hurt the U.S. economy, for instance through rising consumer loan delinquencies. He added the dollar's softness could be an early sign of growing focus on an end to the U.S. tightening cycle.

The dollar rose against a basket of major currencies to around 94.3, inching off 2-1/2-month lows hit last week. The euro slipped to $1.1744, not far from a three-month high of $1.18155 touched on Monday, while the yen changed hands at 112.9 to the dollar, approaching six-month lows set in mid-July.

Oil prices eased off four-year highs above $82 hit on Tuesday but were still set for a fifth consecutive monthly quarter of gains, driven by a looming drop in Iranian exports in the last quarter of the year when global demand heats up.

(Additional reporting by Shinichi Saoshiro in Tokyo; Editing by Andrew Heavens and Kirsten Donovan)