Shares cautious, U.S. yield curve deep in recession territory

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By Wayne Cole

SYDNEY (Reuters) - Asian shares were in a cautious mood on Friday after U.S. Federal Reserve officials fired more warning shots on interest rates, while rising coronavirus cases in China and liquidity strains in its bond market added to uncertainty.

Both the dollar and bond yields were shoved higher overnight when St. Louis Fed President James Bullard said interest rates might need to hit a range from 5% to 7% to be "sufficiently restrictive" to curb inflation.

That was a blow to investors who had been wagering rates would peak at 5% and saw Fed fund futures sell off as markets priced in more chance that rates would now top out at 5-5.25%, rather than 4.75-5.0%.

Two-year yields crept back up to 4.46%, retracing a little of last week's sharp inflation-driven drop of 33 basis points to a low of 4.29%. That left them 69 basis points above 10-year yields, the largest inversion since 1981. [US/]

"The message is about the desire from the Fed to lean against what they would consider premature loosening of financial conditions," said Brian Daingerfield, an analyst at NatWest Markets. "And on that front, message received.

"The Fed seems squarely focused on over-signalling on the tightening front and hoping the data slow to a point where they can have the flexibility to undershoot."

The bond market's warnings of recession were not exactly what Wall Street wanted to hear and they left S&P 500 futures flat, while Nasdaq futures inched up 0.1%.

EUROSTOXX 50 futures added 0.7% and FTSE futures 0.3%.

MSCI's broadest index of Asia-Pacific shares outside Japan bounced 0.5%, after slipping for two sessions.

Chinese blue chips were flat amid reports that Beijing had asked banks to check liquidity in the bond market after soaring yields caused losses for some investors.

There were also concerns that a surge in COVID-19 cases in China would challenge plans to ease strict movement curbs that have throttled the economy.

BOJ NOT FOR TURNING

Japan's Nikkei nudged up 0.1% as data showed inflation running at a 40-year high as a weak yen stoked import costs.

Still, the Bank of Japan argues that inflation is mostly driven by energy costs outside of its control and that the economy needs continued super-easy policies.

The situation was radically different in Britain, where finance minister Jeremy Hunt had just announced tax rises and spending cuts in an effort to reassure markets the government was serious about fighting inflation.

Dire predictions that the economy was already in recession saw sterling stand at $1.1916, off the week's high of $1.2026.

After bouncing overnight, the dollar itself ran into renewed selling and eased to 106.460 on a basket of currencies, back toward a three-month trough of 105.30 touched early in the week. The dollar also edged down 139.78 yen, but held above its recent low of 137.67.

The euro held at $1.0376, having eased from a four-month peak of $1.0481 hit on Tuesday as some policy makers argued for caution on tightening.

ECB President Christine Lagarde will give a keynote speech later on Friday that may offer guidance on which way the majority at the bank may lean.

In commodity markets, the bounce in the dollar and yields left gold at $1,762 an ounce and off a top of $1,786 struck early in the week. [GOL/]

Oil futures regained some ground on Friday, but still nursed steep losses for the week on worries about Chinese demand and ever higher U.S. interest rates. [O/R]

Brent added 79 cents to $90.57, to be down 5.5% on the week, while U.S. crude rose 92 cents to $82.56 per barrel. [O/R]