TOKYO/SINGAPORE (Reuters) - Investors rushed to bet on higher interest rates on Friday, dumping bonds on a conviction the world's top central banks were turning from nursing economies hobbled by a credit crisis to battling inflation.
By Eric Burroughs and Tomasz Janowski
TOKYO/SINGAPORE (Reuters) - Investors rushed to bet on higher interest rates on Friday, dumping bonds on a conviction the world's top central banks were turning from nursing economies hobbled by a credit crisis to battling inflation.
The main Japanese bond futures contract suffered its biggest daily fall in five years, forcing the Tokyo Stock Exchange to call a trading halt for the first time ever.
Euro zone government bonds fell on Friday and U.S. Treasuries took a hit in Asian trade.
!ADVERTISEMENT!Although the bond rout followed news that inflation in Japan had hit a decade peak, expectations of higher rates had been building for days on signs the global economy had seen off the worst of the turmoil ignited by U.S. mortgage defaults.
The biggest shift in outlook has come with the Federal Reserve, which has slashed interest rates by 3 percentage points since September to cushion the U.S. economy from the fallout of the credit crisis.
The Fed is now expected to keep interest rates on hold after a quarter-point trim to 2 percent next week and perhaps tweak the language of its post-meeting statement to reflect that it may be nearly finished after chopping rates from 5.25 percent.
Just a month ago, investors were looking for the Fed to cut to rates as low as 1 percent to help revive the economy.
"Receding expectations for Federal Reserve interest rate cuts, rather than views about a Bank of Japan rate hike, and growing concern for inflation risks are behind the JGB tumble," said Keiko Onogi, senior JGB strategist at Daiwa Securities
SMBC.
There has also been speculation this week that the European Central Bank could raise rates from 4.0 percent after euro zone inflation hit a record high, drawing warnings on price pressures from ECB policymakers.
AUSTRALIAN INFLATION
In Australia, markets awoke to the possibility that the central bank could lift rates for a third time this year after data showed core inflation accelerating at the fastest pace in 17 years and well beyond the Reserve Bank's target.
A renewed focus on inflation and improvement in the appetite for riskier investments like stocks have all conspired to undermine government bonds.
"The market is now moving on the view that the worst is behind us in the subprime related woes, which is spurring a sharp reversal in positions that had bet on a bearish outlook on the economy and financial markets," said Yasuhiro Onakado, chief economist at Daiwa SB Investments.
Japan's Nikkei average jumped 2.4 percent to a two-month high, reflecting the rising confidence among investors that the worst may be over rather than fears about inflation. <.T>
The panic about the financial fallout from the U.S. subprime mortgage crisis peaked in mid-March when U.S. investment bank Bear Stearns collapsed and was taken over by JPMorgan Chase.
Since then quarterly earnings of Citigroup Inc and other financial institutions have stirred hopes that banks have tackled the worst of their asset write-downs.
Central banks have come up with an array of devices to keep money flowing through the pipes of the financial system, including a 50 billion pound Bank of England plan to allow banks to swap mortgage assets for government bonds temporarily.
Now investors are questioning their assumptions about interest rates as global inflation rises and the U.S. economy shows signs it is more resilient than initially thought.
The jump in short-term bond yields in the United States as well as Japan provided the clearest signal yet that investors believe central banks are focusing more on containing inflation than fostering growth.
The two-year U.S. Treasury yield, the most sensitive to the policy outlook, reached a high of 2.51 percent on Friday -- taking it to 26 basis points above the current fed funds target, the most since June 2006.
In Japan, two-year government bond yields shot up as much as 13 basis points to 0.850 percent -- well above the BOJ's 0.5 percent target as the next move is seen as a rate hike instead of a rate cut. Euro zone two-year yields are up a full percentage point from their lows hit in march.
(Editing by Dayan Candappa)
