The prospect of the United States, the world's largest economy, raising interest rates and shrinking its mammoth balance sheet reverberated across markets from Toronto to Beijing on Tuesday.
US Federal Reserve policymakers gather in Washington for their two-day meeting against the backdrop of a slide in tech stocks that serves as a warning of how tighter financial conditions may hurt sectors where valuations appear stretched.
That sell-off, which centred on Wall Street, abated in Asia and Europe on Tuesday, but there were other flash points in currency and debt markets as the Fed's next move was seen potentially influencing central banks in Canada and China.
The US Federal Reserve is widely expected to raise its benchmark interest rate in a decision scheduled for Wednesday and may also provide more details on its plans to shrink $4.5 trillion dollars of assets it amassed to nurse the economic recovery.
The Canadian dollar hit a two-month high after a policymaker said the central bank would assess if it needs to keep rates at near-record lows as the economy grows, while the prospect of the Chinese central bank raising short-term rates has come as its yield curve inverts in a worrying sign for growth.
The gap between benchmark USand European bond yields hit its widest in a month as the Fed meeting also shone a light on the slow pace of change in European Central Bank policy.
“If the Fed is tightening policy and embarking on a gradual normalisation path, whether it is the short-term policy rates or the balance sheet, it wants the market to believe it and to adjust to it,” said Frederik Ducrozet, an economist at Pictet Wealth Management.
“It is not just about complacency and the creation of financial bubbles...but also about its own credibility.”
The Bank of Japan and the Bank of England also meet this week, although no major policy changes are expected.
Stocks rebound
Asian and European stocks rebounded on Tuesday despite US tech stocks having notched up a 3.5 per cent fall over the past two sessions, driven by losses at Apple, Alphabet, Facebook and Microsoft.
European stocks rebounded from seven-week lows in early deals on Tuesday as shares in tech firms recovered and financials rose.
The pan-European STOXX 600 was up 0.5 per cent, partly recovering losses from the previous session following a brutal sell-off in tech stocks. The tech sector was the top sectoral gainer, up 1.1 per cent after posting a 3.6 per cent loss on Monday.
MSCI's broadest index of Asia-Pacific shares outside Japan rose 0.5 per cent, recouping about half of the previous session's losses. The MSCI Asia Pacific Information Technology index steadied, after sliding 1.4 per cent on Monday.
Some analysts had predicted Asian tech shares would not see as intense a sell-off as their US peers as their valuations were less stretched.
“Comparatively, valuations for the IT sector in the Asia-Pacific region are less expensive compared to the US, which may be why we're not seeing the situation further aggravate for a second session,” said Jingyi Pan, market strategist at IG in Singapore.
A small majority of traders in China's financial markets think its central bank will likely raise short-term interest rates again this week if the US Federal Reserve hikes its key policy rate, according to a Reuters poll.
But the reaction to this in bond markets has been concerning.
China's two-year yields have in the last few sessions risen above its 10-year yields - a trend that has only happened in a few instances over the past decade and suggests investors have worries over the long-term health of the world's second biggest economy.
Canadian surprise
In currencies, the Canadian dollar strengthened about 0.4 per cent to trade at C$1.326, after gaining 1.1 per cent on Monday.
Monday's comments from a Bank of Canada official was a change in tone for the central bank, which said earlier this year that rate cuts remain on the table.
“It feels like a long time since markets have been treated to unscheduled hints of tightening, and this was quite apparent when you saw the positive reaction of CAD crosses overnight," Matt Simpson, senior market analyst at ThinkMarkets in Melbourne, wrote in a note.
Against a broad basked of trade-weighted peers, the US dollar was a touch weaker.
Sterling recovered around 0.3 per cent against the euro and the dollar, having fallen almost 3 per cent slide since the first hint of UK election results on Thursday night, helped by hopes domestic politics may be inching towards a “softer” and less economically damaging Brexit.
In commodities, oil advanced on news that Saudi Arabia would make supply cuts to customers.
Brent crude futures were at $48.51 per barrel at 0649 GMT, up 22 cents, or 0.5 per cent, from their last close.