European equities softened on Wednesday while US government bonds steadied after an overnight sell-off sparked by the prospect that a fiscal stimulus deal could feed through to higher inflation.

The Stoxx 600 drifted 0.1 per cent lower in morning trading, having built on its record monthly gain in November with a strong showing on Tuesday. The FTSE 100 crept 0.2 per cent higher after the UK became the first country to approve the Covid-19 vaccine developed by Pfizer and BioNTech.

A bipartisan group of US senators proposed on Tuesday a $908 billion spending plan to break a deadlock between Republicans and Democrats over a second major fiscal package to help the world’s largest economy recover from the coronavirus pandemic. President-elect Joe Biden also called for swift action on spending.

The deal “offered support for those of us saying the Covid crisis is more likely to lead to inflation than deflation”, said Jim Reid of Deutsche Bank.

Government bonds have sold off in recent months as investors bet that a stronger economic recovery, assisted by stimulus and vaccine breakthroughs, will feed through to inflation – knocking the value of bonds. Inflation expectations hit their highest in 18 months on Tuesday.

After a sell-off overnight, the yield on 10-year Treasuries held steady at 0.92 per cent, up from its August low of 0.51 per cent.

The 10-year “break-even” rate, which is derived from prices of US inflation-protected government securities, hit 1.83 per cent on Tuesday, higher than at any point since May 2019. And a swap rate that measures inflation expectations over the second half of the next decade moved to 2.25 per cent – above the Fed’s 2 per cent target.

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Etsy Dwek, head of global market strategy at Natixis, said it was likely the US government would spend between $500m and $1tn in the first quarter of next year on stimulus schemes such as extending emergency unemployment relief and supporting airlines.

A $1tn package, she said, would “plug holes” in people’s incomes and keep small businesses going, but was not enough for inflation to overshoot the 2 per cent target. The core measure of inflation favoured by the US Federal Reserve currently sits at about 1.4 per cent.

Before last month’s election, Democrats had proposed a package of up to $3tn. Such a figure is unlikely, Ms Dwek added, unless next month’s run-off Senate elections in Georgia led to the Democrats also gaining control of the upper house of the US legislature.

The dollar, which had drifted to its lowest since April 2018 on Tuesday as US stock markets hit record highs, traded steadily against a basket of major currencies on Wednesday morning.

Futures markets signalled Wall Street’s S&P 500 and technology-focused Nasdaq 100 would fall 0.1 per cent when New York opens for trade. – The Financial Times Limited 2020



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