US interest rate expectations put brakes on equites

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US and European stocks went into reverse on Thursday as uncertainty about how much further US interest rates would rise continued to dominate sentiment.

Stronger than expected US existing home sales data added weight to the view that US borrowing costs would rise by half a percentage point by May, with 25 basis points of that coming at next week’s Federal Open Market Committee meeting.

Home resales in February unexpectedly rose 5.2 per cent to an annual rate of 6.91m units, against expectations of a decline.

Ian Shepherdson, chief US economist at High Frequency Economics, said the data did not change the big picture of the US housing market.

“Sales follow mortgage applications, which have dropped sharply,” he said. “The sales numbers are noisy from month to month but they cannot continue at this level when mortgage applications are consistent with sales nearer to 6.25m. Expect sales and prices to weaken.”

JPMorgan pointed out that the market’s expectations of US monetary policy had been volatile over the past two weeks as very benign inflation data were countered by more hawkish comments from Ben Bernanke, the chairman of the Federal Reserve.

“We continue to think that, with resource utilisation rates still rising, the Fed is likely to raise rates to 5 per cent by May, and then go on hold for the next several months,” the investment bank said.

“However, unlike market pricing, we expect the Fed to resume raising rates in 2007.”

David Sloan, senior economist at 4Cast in New York, took a more dovish view.

“Following the February consumer price index releases, we concluded that the data were sufficiently benign to suggest that in the absence of a compensating upside shock to core CPI in the March release, or evidence that growth was continuing to run firmly above trend into the second quarter, then the odds were now shaded in favour of a 4.75 per cent funds rate peak.”

Wall Street was further unsettled by disappointing guidance from US software group Adobe Systems.

By midday in New York, the Dow Jones Industrial Average was down 0.4 per cent, the S&P 500 was 0.3 per cent lower and the Nasdaq Composite was off 0.3 per cent.

European stocks finally broke a 10-session run of gains despite a sharp rise for German semiconductor group Infineon amid talk that the long-expected spin-off of its memory chip unit might be imminent.

The FTSE Eurofirst 300 index slipped 0.1 per cent.

Asian equity markets were mixed, with the Nikkei 225 in Tokyo ending flat, Taipei easing back but Hong Kong and Seoul moving higher. Sydney recorded a fresh all-time peak.

The US housing data sent the dollar higher virtually across the board, although Mark Austin, currency strategist at HSBC, warned that the currency market faced a period of lacklustre trade.

“With short-term interest rates more stable and the FOMC announcement on Tuesday already being viewed as the next significant event, activity and volatility in the majors is apt to be limited in the near-term,” he said.

Treasury bonds fell back, sending the yield on 10-year paper back towards 4.8 per cent.

Oil prices rebounded after falling back on Wednesday after news of a dip in US crude inventories last week.

The benchmark US crude future was back above $63 a barrel in late morning trade on Nymex.

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