• Bond selloff gathers steam ahead of large Treasury auction, pushing yields higher
• Surprise big rate hike by RBA adds to jitters about rising borrowing costs, stocks slip
• Dollar climbs as yen tumbles, pound plunges too as Johnson’s woes not over

Fresh bond rout rattles markets

Bond yields surged on Tuesday as investors fretted about how far central banks will go to contain inflationary pressures that are rampaging around the world. US Treasury yields edged lower for most of May as speculation that inflation in America is peaking led to some scaling back of rate hike bets for the Fed. But inflation expectations have started to head up again, with the US 10-year breakeven rate hitting an almost three-week high of 2.75% today.

Ten-year Treasury yields climbed back above 3% yesterday as investors grew doubtful about whether the Fed would pause its tightening cycle later in the year without a very substantial drop in inflation, which doesn’t seem very probable at this point. US CPI data is due on Friday, which although it’s expected to show some moderation in price growth in May, policymakers are unlikely to be satisfied with the evidence just yet.

Moreover, the US Treasury Department has a busy week lined up of new bond issuance so the prospect of a large supply of debt entering the bond market is exacerbating the selloff that got underway at the end of May.

Dollar enjoys modest lift, euro maintains some support

The US dollar was broadly firmer on Tuesday and its index against a basket of currencies was on track for a third straight day of gains. Higher Treasury yields are clearly a factor in the dollar’s latest upswing but other sovereign bond yields have rallied even more, particularly European ones, which explains why its gains have been rather tepid. There’s also an element of risk-off flows in the dollar’s advances as other economies are seen as being more vulnerable to rising interest rates compared to the US.

The European Central Bank is expected to pave the way for its first rate hike in more than a decade on Thursday, but with growth already quite sluggish, investors are worried about a sharp slowdown and even a recession.

Nevertheless, investors were wary about the possibility of the ECB adopting a more hawkish line than expected, limiting the euro’s losses today. The single currency was hovering beneath the $1.07 level, maintaining the past week’s subdued tone after failing to stretch its gains to the $1.08 handle.

Aussie boosted by RBA hike but yen tumbles

The Australian dollar was the day’s best performer even though it pared earlier gains to stand flat versus the greenback in early European trading. The briefly shot up to $0.7245 after the Reserve Bank of Australia hiked rates by a bigger-than-expected 50 basis points, lifting the cash rate to 0.85%.

With Beijing and Shanghai gradually removing their weeks-long virus curbs, the odds of more large rate increases by the RBA have gone up as Australian exporters stand to benefit from China’s reopening.

The RBA’s leap onto the rate hike boat and the ECB expected to follow suit have left the Bank of Japan as the lone dove in the world of central banks. Governor Haruhiko Kuroda reiterated on Tuesday that now was not the time for the BoJ to be thinking about an exit strategy from its stimulus policies.

His comments added to the yen’s pain, having slid sharply this month against all its major peers as Japan’s 10-year yield remains capped at 0.25%. The dollar surged to a new two-decade high of just under 133 yen, while the euro scaled a seven-year high of 142.05 yen.

Johnson’s troubles weigh on pound

The pound steadied a bit as European trading got underway after dipping in overnight trading following Prime Minister Johnson’s vote of confidence yesterday. Although Johnson won the vote, he’s come out much weaker as 148 of his own MPs failed to back him – a bigger amount than expected.

Rather than draw a line under the recent scandals, the confidence vote has raised fresh question marks about Johnson’s leadership, sparking speculation of a snap election. However, as far as the pound is concerned, the biggest risk is if the Johnson government tries to woo voters with pre-election giveaways that could end up worsening the inflation problem by stimulating demand.

Stocks in the red again

In equity markets, European indices opened in the red as US stock futures turned negative after Monday’s modest rise on Wall Street. The S&P 500 closed up 0.3% but the rebound, which looked quite promising a week ago, has sputtered.

There’s quite a bit of uncertainty at the moment in terms of inflation and the growth outlook and until investors have a better idea of how high interest rates will go, equities are likely to struggle.

Even hopes of lower oil prices have been dashed as OPEC’s half-hearted move to boost supply has barely made a dent in the latest rally, while the fighting in eastern Ukraine has intensified in recent days.