Stocks and Bonds Reel Under Stagflation Threat

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LONDON—A selloff in global stocks extended into Tuesday on signs that soaring energy prices had put a dampener on economic growth, while inflation and policy-tightening fears sent short-dated U.S. Treasury yields to 18-month highs.

Oil prices rose further, with Brent crude at almost $89 a barrel. Coal has scaled record peaks and, while gas prices are off recent highs, they remain four times higher in Europe than at the start of the year.

The impact of supply crunches in power and manufacturing components is showing up in data—on Tuesday, data showed Japanese wholesale inflation hit 13-year highs last month, UK shoppers slashed spending and China recorded a 20 percent drop in car sales.

With the U.S. earnings season kicking off in earnest this week, investors will want to gauge the impact of inflation on companies’ bottom line.

While the prospect of weaker economic growth sent stocks lower, inflation fears and the likelihood of central bank policy tightening were reflected in bond markets, where two-year Treasury yields rose to 18-month highs, up 35 basis points since the start of October.

Ten-year yields rose to a four-month high, undeterred by weaker-than-expected U.S. economic data in recent days as money markets priced interest rates rising from end-2022.

“Markets had bought the message that inflation was transitory and now they are questioning it,” said Sarah Hewin, senior economist at Standard Chartered.

“We take the view that the current rise in costs is a headwind to activity and as such will limit the growth rebound.”

A pan-European equity index slipped 0.6 percent, U.S. equity futures pointed to a weaker Wall Street session and MSCI’s global index fell 0.3 percent.

Earlier, Asian shares lost ground too, led by falls of as much as 1.5 percent in Chinese blue chips and Hong Kong.

Asian markets are also under pressure from the situation in China’s property sector, where the stricken Evergrande group missed a third bond coupon payment in as many weeks and signs are growing of trouble at some other developers.

“Investors are eagerly watching if there will be any measures from Beijing to help solve Evergrande’s debt problem, which would need comprehensive plans,” said Zhang Zihua, chief investment officer at Beijing Yunyi Asset Management.

While there is no sign of such assistance, economic momentum is clearly slowing; even before the plunge in car sales, data showed tourism revenues dropped 5 percent year-on-year during the Oct. 1–7 Golden Week, one of China’s busiest travel periods.

All those concerns, alongside rising Treasury yields, are keeping alive the bid for the dollar index, which is a whisker off recent one-year highs and stands near a three-year peak against the yen.

Some analysts fear U.S. data due later this week could increase stagflation fears, if they show CPI above forecast and a drop in retail sales.

“The dollar is the likely near-term winner from these outcomes, with both rates and the risk environment dollar- supportive,” Standard Chartered predicted.

For a graphic on Gas, CO2 and Coal rebased to the start of the year, showing percentage gains:

By Sujata Rao