European stocks head towards all-time highs as Fed fears abate

European equities headed towards all-time highs on Tuesday after US central bankers soothed concerns about the Federal Reserve withdrawing its pandemic crisis monetary support.

The Stoxx 600 index opened 0.7 per cent higher at 445.2 points, close to its closing record of 445.4 on May 10. London’s FTSE 100 added 1 per cent.

An estimate of eurozone GDP growth released later on Tuesday is expected to show that the bloc’s economy contracted 1.8 per cent in the first quarter, year on year. This would put its economic recovery from the pandemic far behind that of the US, which is rebounding strongly.

Investors and analysts say that European equity returns are more driven by central banks’ monetary policies, however, with the US Fed as the world’s most influential rate setter.

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Policy

“Over recent years, monetary policy has been the key driver of market returns,” said Guilhem Savry, a strategist at asset manager Unigestion.

Professional forecasters surveyed by the Philadelphia Federal Reserve expect average consumer price inflation of 2.3 per cent in the US, above the central bank’s target, for the next 10 years. US consumer price inflation jumped 4.2 per cent in April over the same month last year.

But Fed officials have insisted that the central bank needs to continue its $120 billion (€99 billion) a month of asset purchases and to keep rates anchored near zero until the US labour market recovers from the pandemic.

“We are still 8 million jobs short of where we were pre-pandemic,” Atlanta Fed president Raphael Bostic told CNBC on Monday.

“Until we make substantial progress to close that gap, I think we’ve got to have our policies in a very strongly accommodative situation or stance.”

Brent crude futures hit $70 a barrel, a level only reached once since January last year, driven higher by an investment boom into commodities as traders looked to hedge their stock and bond portfolios from inflation risks.

“If you think the inflation regime will change more than markets expect, and you want to hedge this, the best way is to add cyclical commodities to your portfolio,” Unigestion’s Savry said.

Commodities

On Tuesday, the price of spot gold hit $1,869.5 an ounce, its highest since January. “Commodities, such as wheat, gold, and oil, tend to be highly correlated to inflation,” Steve Rodosky and Lorenzo Pagani, of asset management company Pimco, wrote in a research note.

“Investments in commodities can offer some of the highest levels of inflation hedging of any asset class, though they may also be subject to volatility.”

Government bonds, which dropped sharply in price during the first quarter of this year, have steadied in recent weeks as investors banked on the Fed continuing its asset purchase programme, even though bonds’ real returns are eroded by inflation.

The yield on the benchmark 10-year US Treasury, which moves inversely to its price, was steady at 1.645 per cent on Tuesday, up from about 0.9 per cent at the start of the year.

The dollar index, which measures the greenback against key currencies, dropped 0.3 per cent as traders banked on US interest rates staying low for longer. The move helped to lift sterling 0.4 per cent higher against the dollar to $1.419. The euro gained 0.4 per cent to $1.220.

In Asia, Tokyo’s Topix closed 1.5 per cent higher and Hong Kong’s Hang Seng index added 1.3 per cent. – Copyright The Financial Times Limited 2021