Stocks hit 2-year low as central banks step up the war on inflation

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By Tom Westbrook and Amanda Cooper

LONDON/SYDNEY (Reuters) - Stocks hit two-year lows on Friday and bonds faced an eighth weekly loss, as investors digested the prospect of a far more aggressive rise in U.S. interest rates, while currency markets remained volatile after Japan's intervention to prop up the yen.

Interest rates rose sharply this week in the United States, Britain, Sweden, Switzerland and Norway - among other places - but it was Federal Reserve's signal that it expects high U.S. rates to last through 2023 that set off the latest sell-off.

MSCI's world stocks index fell to its lowest since mid-2020 on Friday, having lost about 12% in the month or so since Fed Chair Jerome Powell made clear that bringing down inflation would hurt.

The euro fell for a fourth straight day after data showed the downturn in the German economy has worsened in September, as consumers and businesses face an unprecedented energy crunch and spiralling inflation.

European stocks were a sea of red for a second day, under pressure from losses in everything from bank stocks to natural resources and technology shares. (EU)

The pan-regional STOXX 600 was down about 0.5% in early trade, while Frankfurt's DAX lost 0.6%, ranking it as one of Europe's worst-performing indices. London's FTSE lost 0.1%, against a backdrop of the pound tumbling to another 37-year low.

"Pretty much anything besides inflation data and central bank policy decisions is just noise at the moment, with the market firmly, and almost solely, focused on how high rates will rise across developed markets, and how long they will remain at those peaks," CaxtonFX chief strategist Michael Brown said.

"The Fed's message on Wednesday was clear, that rates are going higher than the market was pricing, and policy will remain restrictive for a prolonged time to come, likely throughout 2023 - in that environment, it's almost impossible to be long stocks, or to want to buy Treasuries, hence the sell-off in both is no surprise, and should continue."

S&P emini futures fell 0.3%, suggesting a weaker start on Wall Street later.

With U.S. rates set to rise faster and stay high for longer, the dollar hit its highest in two decades this week, while yields on the benchmark 10-year US Treasury have soared as investors have ditched inflation-sensitive assets like bonds.

The 10-year yield was trading down 2 basis points on the day at 3.68%, but has risen by almost a quarter of a percentage point this week alone and is on course for its eighth consecutive weekly increase.

"The 10-year was playing catch up to the newly calibrated cash rate," said Westpac's head of rates strategy, Damien McColough, in Sydney.

"If you believe the front-end is going to peak at 4.60% can you really sustain 10-year bond yields at 3.70%?" he said.

"It's very skittish price action ... I think that this volatility continues in all markets in the near term (until) the rates market settles."

The euro and yen fell to 20-year lows on Thursday, until Japanese authorities stepped in to the market for the first time since 1998 to buy yen and arrest its long slide.

The yen was last steady at 142.29 per dollar and on course for its best week in more than a month, but few believe this strength will last.

Meanwhile, two-year gilt yields headed for their worst week in 13 years after the Bank of England delivered an interest-rate rise that was smaller than some currency traders had hoped for.

Later on Friday, new finance minister Kwasi Kwarteng will announce a fiscal plan that is probably inflationary and even more bad news for gilts..

Gold, which pays no interest, has come under pressure, particularly over the course of this quarter, as yields have risen. It was last down 0.1% on the day around $1,667 an ounce, at its weakest in two years.