Rate fears knock stocks as Russia switches off gas tap

© Reuters. FILE PHOTO: A man wearing a protective mask amid the coronavirus disease (COVID-19) outbreak, walks past an electronic board displaying Japan's Nikkei index outside a brokerage in Tokyo, Japan August 29, 2022. REUTERS/Kim Kyung-Hoon

By Huw Jones

LONDON (Reuters) - Stocks eased on Wednesday after Russia switched off a key gas tap to Europe, compounding fears of recession just as central banks on both sides of the Atlantic prepare to raise borrowing costs again next month.

Oil added to Tuesday's hefty losses, while the dollar was helped by stronger-than-expected U.S. jobs data underpinning expectations of a hefty interest rate rise next month.

The MSCI all country stock index was flat on the day and down 18.5% for the year. The STOXX share index of 600 companies eased 0.25%, leaving it down about 14% for the year after rate hikes and war in Ukraine took their toll.

Economic news remained grim with overnight data showing that economic activity in China, the world's second largest economy, extended its decline this month after new COVID infections, the worst heatwaves in decades and struggles in the property sector.

Headline euro zone inflation for August is expected to show an acceleration to 9% year-on-year in data due at 0900 GMT.

Russia halted gas supplies via a major pipeline to Europe on Wednesday for three days of maintenance amid doubts it won't be switched back on, adding to worries of energy rationing during coming winter months in some of the region's richest countries. The energy crunch has already created a painfulcost-of-living crisis for consumers and businesses, and forcedgovernments to spend billions to ease the burden.

German bond yields were set to end August with their biggest monthly surge in more than 30 years as investors hunker down for a period of higher inflation and interest rates.

Graphic: German 2-year bond yield set for biggest monthly jump since 80s - https://fingfx.thomsonreuters.com/gfx/mkt/znpnewdbkvl/DE3108.png

Markets are betting that the U.S. Federal Reserve and the European Central Bank will both raise their key borrowing costs by 50 or 75 basis points when they meet next month.

Jamie Niven, a senior bond fund manager at Candriam, said rate hikes anticipated for this year have been largely priced into markets, especially in the United States.

Investors have begun pricing out previously anticipated rate cuts next year following Fed Chair Jerome Powell's hard-hitting speech last week.

"I think there is more pain to come in credit markets and in equity markets before we see a brighter outlook. I don't think central banks are going to be in a state where they can cut to kind of soften the blow of recession," Niven said.

While there may be occasional quick flips or dramatic rallies back into riskier assets like stocks at times, they will ultimately be lower towards the end of the year, Niven said.

U.S. non-farm payrolls data due on Friday could make the case for a big rate hike, analysts said.

U.S. e-mini equity futures pointed to a 0.2% rise for the S&P 500 after its 1.1% slide on Tuesday.

CRUDE EXTENDS LOSSES

In Asia overnight, Japan's Nikkei sagged 0.4% and Chinese blue chips were little changed. Hong Kong's Hang Seng was down 0.16%, recovered from steep early declines.

The two-year U.S. Treasury yield, which is relatively more sensitive to the monetary policy outlook, hit a 15-year high at 3.497% overnight, but eased back to 3.4602%.

The 10-year Treasury yield, which hit a two-month high of 3.153% on Tuesday, stood at 3.1025%.

The dollar index, which measures the currency against six major peers, was up 0.12% at 108.89, after starting the week by marking a two-decade high at 109.48.

Gold was slightly weaker at $1,720 an ounce, hovering near a one-month low of $1,719.56 set on Monday.

Crude oil fell further after declines of more than $5 overnight, but drew support after industry data showed U.S. fuel stocks fell more than expected.

U.S. West Texas Intermediate (WTI) crude futures were down 0.37% at $91.27 a barrel, after sliding $5.37 in the previous session driven by recession fears.

Brent crude futures for October fell 0.35% to $98.93 a barrel after falling $5.78 on Tuesday.