Stocks edge higher, dollar sags eyeing Fed pause

By Yoruk Bahceli

(Reuters) – Global shares edged higher and the dollar held near three-week lows on Wednesday as traders were all but certain that the U.S. Federal Reserve will refrain from hiking interest rates later in the session.

The much-watched U.S. CPI report on Tuesday showed prices barely rose in May, with just a 0.1% increase from the prior month. On an annual basis, consumer prices rose 4%, the smallest in more than two years, slowing from April’s 4.9%.

That has crystallised traders’ views that the Fed is unlikely to hike rates later on Wednesday. They now see more than a 90% chance of the bank staying put.

Expecting a pause global stock markets were in an upbeat mood. Europe’s pan-regional index was up 0.7% by 1128 GMT. and Nasdaq futures were both up 0.2%, setting Wall Street for further gains after U.S. stocks rallied to 14-month highs overnight.

“Having already flagged the possibility of a pause I think it’s unlikely that (the Fed) would veer off course at this particular juncture,” said Richard McGuire, head of rates strategy at Rabobank in London.

“They do clearly appear to be approaching this on a somewhat cautious basis given the elevated level of uncertainty. The CPI data yesterday was pretty much bang in line so nothing there to challenge this outlook.”

The U.S. dollar dropped 0.2% against major peers, hovering near a three-week low it hit on Tuesday. That supported the euro, which was up 0.1% to $1.0850, hovering just below Tuesday’s three-week high of $1.08235.

Market pricing suggests a pause is all but certain, but traders are also bracing for the possibility of a hawkish surprise, with a 60% probability of a 25 basis-point hike priced in by July.

While U.S. inflation dropped more than expected in May, core inflation which strips out volatile prices remains elevated in a headache for the Fed.

“That persistence means that investors still think that today will only mark a skip on rate hikes rather than a pause,” said Deutsche Bank (ETR:) strategist Jim Reid.

After hitting the highest since March on Tuesday, two-year Treasury yields were down 2 bps to 4.67%, after reversing some of the drop they posted in earlier London trade.

The benchmark 10-year yield was down similarly after hitting the highest in 2-1/2 weeks on Tuesday.

In the UK, where data showing a rapid pickup in UK wage growth on Tuesday has prompted traders to raise their bets on Bank of England rate hikes, sterling touched a fresh one-month high of $1.26500.

UK government bonds calmed on Wednesday and two-year yields were 5 basis points lower on the day, following Tuesday’s sell-off that sent them 25 basis points higher, above levels seen during September’s “mini budget” crisis.

German two-year bond yields touched a fresh high since March ahead of Thursday’s European Central Bank rates decision.

Oil prices rose more than $1 on the day with futures up 1.4% to $75.33 per barrel, supported by bullish demand forecasts from the International Energy Agency. [O/R]

Stocks also had an upbeat session in parts of Asia. Tokyo’s continued to outperform, closing at a fresh 33-year high, ahead of the Bank of Japan’s policy meeting on Friday where it is expected to maintain its ultra-loose policy.

Chinese blue chips marked the fifth straight session of gains on hopes for more economic stimulus, which could come on Thursday when China’s central bank is expected to cut rates on medium-term policy loans, following a short-term lending rate cut on Tuesday.

But Chinese stimulus is denting the yuan, which fell to a 6-1/2 month low following Tuesday’s rate cut and anticipation of more.

Gold prices were last up 0.15% at $1,946.39 per ounce