By Herbert Lash
NEW YORK (Reuters) - Treasury yields fell and a gauge of global stocks eased on Wednesday after the market was rattled by minutes from the Federal Reserve's last policy meeting that indicated banking sector stress could tip the economy into a recession.
Fed staff assessing the potential fallout of banking stress projected a "mild recession" later this year. But the minutes showed policymakers ultimately agreed to higher interest rates as data at the time showed few signs of inflation pressures abating.
"We've had some calm with banking turmoil, and there's just this feeling that it could pick up again over these next couple of weeks," said Edward Moya, senior market analyst at OANDA in New York. "I would not be surprised if we saw more banks under pressure here."
Earnings season begins in earnest on Friday, with major U.S. banks set to report their results.
Stocks on Wall Street and in Europe earlier rallied after data showed cooler-than-expected U.S. headline inflation in March, raising hopes the Fed could pause monetary tightening following a 25-basis-point rate hike next month.
U.S. consumer prices barely rose as the cost of gasoline declined 4.6%, but stubbornly high rents kept underlying inflation simmering, likely ensuring that the Fed will raise interest rates after policymakers meet on May 2-3.
Gold prices rose and the dollar fell after data showed the Consumer Price Index (CPI) climbed 0.1% last month, or half the rate of market expectations, after advancing 0.4% in February.
But inflation is still running well above the Fed's 2% target, causing market angst as investors try to assess when the U.S. central bank might pause its hiking campaign to slow inflation.
"Right now the conversation is all about when the Fed starts to move in a different direction," said Johan Grahn, head ETF market strategist at Allianz (ETR:ALVG) Investment Management in Minneapolis.
"I don't think the Fed will move until it's painful enough that people are going to shy away from placing their chips on the equity market," he said.
Anthony Saglimbene, chief market strategist at Ameriprise Financial (NYSE:AMP) in Troy, Michigan, said the CPI data confirms that inflation trends are moving in the right direction.
"But from the market's perspective, it might be getting ahead of itself because I don't think the Fed will be cutting rates this year," Saglimbene said of investor sentiment.
Money markets initially trimmed expectations for a Fed rate hike in May, pricing in a 65.2% chance of a 25-basis-point move, CME Group's (NASDAQ:CME) FedWatch Tool showed. But the probability of a hike in May later rose to above 70% before paring some gains.
Markets still are pricing the Fed to cut its target rate to 4.336% by December, slightly less than the day before, as the economy slows and potentially enters a recession.
With core CPI, which excludes volatile food and energy components, rising 5.6% after a 5.5% rise in February, markets had been leaning toward further tightening.
Odds point to Fed rate hike in May https://www.reuters.com/graphics/USA-RATES/FEDWATCH/zdpxdayyrpx/chart.png
Inflation may be falling, but it has yet to do so at a rate commensurate with the Fed's 2% goal, Richmond Fed President Thomas Barkin said in remarks on Wednesday that threw cold water on the market's initial exuberance over the CPI data.
"I'm waiting for inflation to crack," Barkin told broadcaster CNBC. "It's moving in the right direction ... but in the absence of a month or two months or three months with inflation at our target, it's hard to make the case that we're compellingly headed there."
The Canadian dollar strengthened against the greenback after the Bank of Canada left its key overnight interest rate on hold at 4.50% as expected and raised its growth forecast for 2023, while dropping language warning of a potential recession.
European Central Bank policymakers also made the case for more rate hikes on Wednesday but offered contrasting views on just how much more tightening is needed, suggesting the debate over the bank's next move is not yet settled.
MSCI's gauge of stocks across the globe closed down 0.08%, while the pan-European STOXX 600 index rose 0.13%.
On Wall Street, the Dow Jones Industrial Average closed down 0.11%, the S&P 500 lost 0.41% and the Nasdaq Composite dropped 0.85%.
In Asia, MSCI's broadest index of Asia-Pacific shares outside Japan was 0.16% lower in choppy trading, snapping a three-day winning streak.
BONDS UP, DOLLAR DOWN
U.S. bond yields fell. Rate-sensitive two-year Treasury yields declined 8.8 basis points to 3.970% and the 10-year slid 3 basis points to 3.404%.
The dollar fell with an index measuring the U.S. currency against six peers down 0.558%. The euro rose 0.71% to $1.0987 and the yen strengthened 0.36% versus the greenback at 133.20 per dollar.
Elsewhere, U.S. crude rose $1.73 to settle at $83.26 a barrel, while Brent settled up $1.72 at $87.33.
U.S. gold futures settled 0.3% higher at $2,024.90 an ounce.
Bitcoin fell 1.21% to $29,881.00.