Stocks, bond yields dip as U.S. data muddies Fed rates outlook

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By Herbert Lash and Danilo Masoni

NEW YORK/MILAN (Reuters) -World stocks slid further and Treasury yields weakened on Wednesday as U.S. worker productivity data beat forecasts but extended a weak trend, further muddying a debate on how far and how fast U.S. interest rates will rise.

Third quarter productivity rebounded at a slightly faster pace than initially thought. Economists said the reading pointed to elevated labor costs and inflation staying high, adding pressure on the Federal Reserve to keep raising rates.

But benchmark U.S. yields and the dollar both fell.

"Slower rate hikes have been the trend globally of late, but the Fed remains a wild card. Overall, it's a fickle, anxious market ahead of next week’s Fed meeting," said Joe Manimbo, senior market analyst at Convera in Washington.

The S&P 500 and Nasdaq also lost ground, adding to the prior day's sell-off on warnings by three major U.S. banks of a looming recession, as questions about how sticky inflation might be kept alive uncertainty about the Fed's policy path.

"Looking back in previous decades of high levels of inflation, it usually takes a few years for inflation to moderate," said Chris Dyer, director of global equity at Eaton (NYSE:ETN) Vance in London.

"Earnings estimates in aggregate across the globe probably need to go down for 2023," Dyer said. "Those (companies) that have pricing power and higher quality business models will be able to prove more resilient." MSCI's gauge of stocks across the globe shed 0.26%, while the broad European STOXX 600 index lost 0.62% to mark its fourth straight drop as fears of a global recession intensified.

On Wall Street, the Dow Jones Industrial Average rose 0.18%, the S&P 500 gained 0.00% and the Nasdaq Composite dropped 0.31%.

Many in the market believe inflation is moderating and bond yields have peaked, allowing the Fed and other central banks to begin slowing rate hikes when policy-makers meet next week.

The Bank of Canada signaled on Wednesday that its historic tightening campaign was near an end as it raised benchmark overnight interest rates by 50 basis points to the highest level in almost 15 years.

Earlier, India slowed the pace of rate increases with a 35 basis point hike of its key lending rate to 6.25%, smaller than the three 50 bp hikes it delivered previously.

While Fed Chair Jerome Powell has warned the fight against inflation is far from over, he said late last month that the Fed could ease the pace of its rate hikes as soon as December.

Powell's comments have prompted the market to price in a lower peak interest rate, which Fed funds futures showed on Wednesday was 4.933%, down from a recent high of 5.1%.

The yield on benchmark 10-year Treasury notes fell 6.7 basis points to an almost three-month low of 3.446%.

Gold prices rose, helped by a retreat in the dollar and Treasury yields, as investors anticipate the projection of slower rate hikes at the Fed's meeting on Dec. 13-14.

Spot gold rose 0.6% to $1,782.28 an ounce.

The dollar slipped as traders weighed up an uncertain economic outlook, while China's yuan firmed as authorities loosened some of the country's zero-COVID rules.

The euro gained 0.42% to $1.0513, and the yen strengthened 0.49% to 136.35 per dollar.

China's national health authority said on Wednesday that asymptomatic COVID-19 cases and those with mild symptoms can self-treat while in quarantine at home, the strongest sign so far that Beijing is preparing to live with the disease.

Market reaction was negative as the focus shifts to how well China can execute its policy shift.

"It is difficult to assume that China's reopening will not be inflationary when the opposite was true for the rest of the world and that will be the challenge heading into 2022," said Geoff Yu, strategist at BNY Mellon (NYSE:BK).

The Shanghai Composite Index fell 0.4%, Hong Kong's Hang Seng slumped 3.2% and the yuan firmed 0.3% to 6.9768 per dollar.

Oil edged to its lowest since the start of the year in volatile trading, after U.S. government data showed an unexpectedly large build in fuel stocks, feeding fears about demand in a market already spooked by an uncertain economy.

U.S. crude fell 1.72% to $72.97 per barrel and Brent was at $78.09, down 1.59% on the day.