(Reuters) – U.S. benchmark bond yields hit a two-year high on Monday and emerging market currencies from India to Indonesia tumbled as markets braced for the Federal Reserve to start withdrawing support for the U.S. economy.
U.S. stocks were mixed while political uncertainty in Italy hurt Italian bank shares, dragging down the broader European market. Fear that the Fed will scale back stimulus spending next month battered Wall Street last week, with the Dow industrials putting in their worst weekly run of the year.
Minutes from the Fed’s last policy meeting will be released on Wednesday and could shed light on when the central bank plans to slow its $85 billion-a-month in bond purchases, a prospect that has been making markets nervous for months.
The Fed has said it expects the economy to strengthen in the second half of this year and into 2014, and recent U.S. data has suggested labor market improvement and rising price pressure.
That has pushed long-term interest rates up sharply over the last few months, with the U.S. benchmark 10-year Treasury yield hitting a two-year high of 2.875 percent on Monday, up more than a percentage point since May.
German 10-year government bond yields rose 1.3 basis points to 1.89 percent, having earlier hit their highest since March 2012 at 1.92 percent.
However, Fed policymakers have also stressed that any sign of weakness could delay the timetable for tapering bond purchases.
“What you are seeing at the moment in a way is central bankers versus the markets,” said ABN Amro economist Nick Kounis. “The markets are pushing up the rate (increase) expectations and central bankers have been trying to pour cold water on the moves, but it is proving more difficult against a background of stronger economic data.”
The Dow Jones industrial average .DJI was down 12.13 points, or 0.08 percent, at 15,069.34. The Standard & Poor’s 500 Index .SPX was down 1.09 points, or 0.07 percent, at 1,654.74. The Nasdaq Composite Index .IXIC was up 15.09 points, or 0.42 percent, at 3,617.87
Capital-intensive industries such as miners and utilities could suffer most if Fed tapering keeps interest rates rising.
“Anybody with a large amount of short-term debt,” said Kim Forrest, senior equity research analyst at Fort Pitt Capital Group in Pittsburgh. “And if they pay a dividend, it can be at risk.”
European shares have held up better in recent weeks. The 17-country euro zone ended an 18-month recession last quarter, growing 0.3 percent, and August business surveys this week are likely to show the modest recovery is slowly broadening out.
But a sharp slide in Italian stocks on Monday weighed on the FTSEurofirst 300 .FTEU3, which shed 0.6 percent. Uncertainty about the strength of Italy’s coalition government hurt shares.
An index of global stocks fell 0.3 percent. .MIWD00000PUS
EMERGING TURBULENCE
While higher interest rates can cause trouble for developed governments with large deficits, they are also hurting emerging markets that have benefited from large cash inflows courtesy of the Fed’s and other central banks’ loose monetary policies.
The Indian rupee slid to a record low of 63.30 per dollar, while the country’s stock market .NSEI lost 1.4 percent, extending a 4 percent drubbing sustained on Friday.
“With the turnaround of developed markets, foreign institutional investors have greater investment opportunities in Western Europe and North America,” said Sourindra Banerjee, a professor at Warwick Business School in Britain. “This situation is aggravated with the tapering of quantitative easing.”
India’s central bank has tried to restrict how much money Indian residents and companies can send offshore, but that only raised fears of outright capital controls that would further undermine the confidence of foreign investors.
Indonesia’s rupiah fell to a four-year low of 10,485 per dollar and the strain also showed in MSCI’s broadest index of Asia-Pacific shares excluding Japan .MIAPJ0000PUS, which fell 0.5 percent.
Crucial data later in the week will be an early reading on Chinese manufacturing from HSBC. Recent data suggested the economy might be stabilizing and any improvement in the purchasing manager index will be welcomed by Asian investors.
Eventually higher U.S. yields should make the dollar more attractive. But the greenback has struggled in recent weeks, partly on worries that reduced Fed bond purchases would drive investors out of U.S. fixed-income markets.
The dollar was down about 0.1 percent at $1.3345 per euro, little moved from Friday. Against the yen it rose 0.4 percent to 97.95.
“We think over time the dollar will begin to outperform against the major currencies, but at the moment it is being offset by higher (bond) yields in Europe, where markets have been very much focused on the improving cyclical momentum,” said Lee Hardman, a currency analyst at Bank of Tokyo-Mitsubishi.
U.S. crude oil prices fell 46 cents to $107.06 a barrel as oil markets remained focused on the violent unrest in Egypt, which has stoked fears for exports from oil producers in the Middle East and North Africa.
Copper slid 1 percent to $7,330 a ton after hitting a 10-week peak of $7,420 on Friday, while gold fell 0.9 percent to $1,375.79.
(Additional reporting by Marc Jones in London; and Rodrigo Campos in New York; Editing by Dan Grebler)
