European shares fall as traders weigh Russia-Ukraine talks and economic outlook

A rally in European stocks paused on Wednesday, as investors assessed the outlook for inflation and interest rate rises beyond a possible peace deal in Ukraine.

The regional Stoxx 600 index, which closed on Tuesday at its highest level since February 17 after Moscow said it would reduce its military operations near Ukraine’s capital, Kyiv, lost 0.6 per cent. London’s FTSE 100 added 0.1 per cent and Germany’s Xetra Dax dropped 1.3 per cent.

In government debt markets, yields on shorter-dated Treasury bonds — which move inversely to their prices and have raced higher this year as traders look to aggressive interest rate rises ahead — also fell back.

March has marked the worst month for Treasuries since July 2003, with the Bloomberg US Treasury Aggregate index dropping 3.5 per cent.

On Tuesday, the two-year Treasury yield had briefly risen above that of the benchmark 10-year US note, a rare event that has historically preceded recessions.

Global equities have recovered from a bout of panic selling in early March, prompted by Russian President Vladimir Putin’s invasion of Ukraine, with the FTSE All World index trading at its highest level since February 11. But investors widely see the bounceback as vulnerable to companies’ earnings being hit by elevated inflation or central banks raising borrowing costs to contain soaring prices.

“It is too soon from a portfolio positioning perspective to start really preparing for a recessionary shock,” said Gregory Perdon, co-chief investment officer at Arbuthnot Latham. “But there is more risk because the guarantee of [central bank] support is no longer there.”

In the US, money markets have priced in more than seven interest rate rises this year. The European Central Bank is also rolling back its ultra-supportive, pandemic-era monetary policies.

“We may be seeing this equity rally for the wrong reasons,” said César Pérez Ruiz, chief investment officer at Pictet Wealth Management.

“People who were holding bonds and worried about losing money switched to equities to protect themselves,” he added, noting that shares in companies with adequate pricing power to pass on inflationary pressures to customers might perform well “as long as economic growth is here”.

In debt markets on Wednesday, the yield on the two-year Treasury note fell 0.03 percentage points to 2.33 per cent, close to its highest since May 2019. The benchmark 10-year yield sat just above the two-year, at 2.41 per cent.

In Asia, Hong Kong’s Hang Seng share index rose 1.4 per cent, after gains on Wall Street on Tuesday. Japan’s Nikkei 225 fell 0.8 per cent. The yen rose 0.8 per cent to 121.8 per dollar, having hit a seven-year low against the US currency on Monday.