Global shares decline, bond yields slide and dollar rallies amid inflation fears

By Katanga Johnson

WASHINGTON (Reuters) - World equities and U.S. bond yields fell on Monday as investors prepare for fresh inflation data and corporate earnings that may be seen as potentially influencing the Federal Reserve’s path ahead for interest-rate increases.

The pan-European STOXX 600 index lost 0.50% and MSCI's gauge of stocks across the globe shed 1.17%.

The euro hovered just above parity versus the dollar as the biggest single pipeline carrying Russian gas to Germany entered annual maintenance, with flows expected to stop for 10 days.

Euro zone bond yields fell while long-term inflation expectations dropped below 2% as recession fears deepened after warnings about the possible cut in Russian gas supplies.

Germany's 10-year government bond yield, the euro zone benchmark, fell 5 bps to 1.296%. It hit a five-week low at 1.072% last week.

Underlining the global nature of the inflation challenge, central banks in Canada and New Zealand are expected to tighten policy further this week. [NZ/INT][CA/INT]

Wall Street, which was off to a strong start in July after a brutal first half of the year, further declined as traders fear another round of heavy sell-off if company results fail to meet expectations this month.

The dollar index rose 0.869%, with the euro down 1.2% to $1.0061.

The market mood will be tested by earnings from JPMorgan and Morgan Stanley on Thursday, with Citigroup and Wells Fargo the day after.

"Not only are people worried that earnings are going to come in weak because of an economic slowdown, but also because of the rise of the U.S. dollar, which creates a headwind for earnings for multinationals," said Robert Pavlik, senior portfolio manager at Dakota Wealth Management.

The Dow Jones Industrial Average fell 0.42%, the S&P 500 lost 1.04% and the Nasdaq Composite dropped 2.02%.

Later in the week, a raft of U.S. economic data - including consumer prices, retail sales and factory output - should provide a glimpse of the extent to which inflation has peaked and the economy has cooled down as the Federal Reserve moves closer to next week's policy meeting, which is expected to culminate in the second straight 75 basis points interest rate hike.

Chris Zaccarelli, chief investment officer at Independent Advisor Alliance in Charlotte, North Carolina, said his position remains cautiously optimistic," but investors' worry about a recession should not be ignored.

"We believe the headwinds to the economy and the market are substantial as inflation remains too high. ... However, we acknowledge that a lot of bad news has already been priced in, with the Nasdaq down and the S&P 500 continuing to decline from all-time highs," Zaccarelli said.

MSCI's broadest index of Asia-Pacific shares outside Japan closed 2.07% lower, while Japan's Nikkei rose 1.11%. Chinese blue chips lost 1.9% after Shanghai discovered a COVID-19 case involving a new subvariant, Omicron BA.5.2.1.

PARITY PARTY

A hawkish Fed, combined with fears of recession, particularly in Europe, has kept the dollar up at 20-year highs against a basket of competitors.

The Japanese yen weakened 0.86% versus the greenback at 137.27 per dollar, while Sterling was last trading at $1.1894, down 1.11% on the day.

Japan's conservative coalition government was projected to have increased its majority in upper house elections on Sunday, two days after the assassination of former prime minister Shinzo Abe.

The euro continued to struggle, recently trading down 1.2% to $1.006, having shed 2.4% last week to hit a two-decade low and major retracement target at $1.0072.

"With little economic relief on the horizon for Europe, and U.S. inflation data likely to mark a new high for the year and keep the Fed hiking aggressively, we think the risks remain skewed in favour of the greenback," said Jonas Goltermann, a senior markets economist at Capital Economics.

"Indeed, we think the EUR/USD rate will break through parity before long, and may well trade some way through that level."

Rising interest rates and a strong dollar have been a headache for non-yielding gold, which was ailing at down 0.5% to $1,733.67 an ounce, having fallen for four weeks in a row. [GOL/]

Oil prices also lost around 4% last week as worries about demand offset supply constraints. [O/R]

U.S. crude recently fell 0.97% to $103.77 per barrel and Brent was at $106.78, down 0.22% on the day.[O/R]

Data from China due on Friday is likely to confirm the world's second largest economy contracted sharply in the second quarter amid coronavirus lockdowns.

(Reporting by Katanga Johnson in Washington, Lawrence White in London and Wayne Cole in Sydney; Editing by Kirsten Donovan, Mark Heinrich, Alison Williams and Jonathan Oatis)