The dollar surged on Wednesday as strong data and expectations of rising global interest rates pushed U.S. Treasury yields to five-year peaks, while stocks were volatile as growth prospects balanced the rise in yields.
U.S. retail sales rose 1.4 percent in May, much stronger than the 0.6 percent expected by economists, adding weight to arguments that the next move by the Federal Reserve on interest rates will be higher, not lower. U.S. import prices also rose much more strongly than expected.
The bond market just can't catch a break, said Mark Vitner, an economist at Wachovia Securities. The economy is coming back stronger than anybody could imagine.
Yields on benchmark 10-year Treasury notes spiked to 5.33 percent in early European trade, their highest since 2002 and above the fed funds rate target of 5.25 percent.
However, yields quickly retreated in volatile trade after the data, with 10-year notes back at 5.25 percent by 1300 GMT.
European stocks turned positive and U.S. stock futures were pointing to a firmer start on Wall Street as investors bet the strong economy would support profits and offset the rise in bond yields, which affect equity valuations, borrowing costs and long-term growth.
Bond yields have risen sharply in recent weeks as central banks tightened monetary policy and after stronger U.S. data killed off expectations of rate cuts from the Federal Reserve.
We've been through a three- or four-year period where yield curves have been a weird shape, said Tim Bond, head of asset allocation at Barclays Capital. I think you've got further to go, yield curves are just normalizing.
Higher bond yields should not impact too heavily on equities, which would remain cheap even if yields rose another 100 basis points, but could hurt corporate bonds, Bond said.
To me credit spreads are the shoe that hasn't dropped yet. I think it's immensely bearish for credit markets.
The spread of Europe's iTraxx Crossover index of 50 mainly junk-rated companies widened to around 212 basis points over Treasuries, up from 190 a couple of weeks ago.
The dollar rose strongly as the higher U.S. bond yields lured investors from other currencies. The dollar rose as much as 0.7 percent to 122.45 yen, levels not seen since late 2002.
Carry trade investors have borrowed the low yielding Japanese and Swiss units to pick up easy returns by investing in high yielding currencies such as the New Zealand and Australian dollars.
The Swiss franc fell to a four month low of 1.2453 per dollar before an expected increase in interest rates by the Swiss National Bank on Thursday.
The euro was up 0.6 percent at 162.72 yen but fell as low as $1.3264 to the dollar, its weakest since late March.
Equities struggled as higher yields diminished their valuation appeal versus bonds, with MSCI's All-Country World Index down 0.2 percent.
Interest rate-sensitive financial and property stocks were among the worst hit in Europe and Asia as traders worried about rising bond yields curbing margins.
Europe's FTSEurofirst 300 was up 0.3 percent to 1,579 points, down almost 4 percent from a 6-1/2 peak last week, but .
Everyone knew that bond yields had to go up, said Andrew Lynch, a European fund manager at Schroders. It's important to think why they are going up. Economic growth remains strong and companies are starting to be able to put up end-market consumer prices.
In Asia, the Nikkei fell 0.2 percent and MSCI's index of stocks elsewhere in Asia fell 0.8 percent, but Shanghai stocks jumped 2.6 percent in heavy trade.
Commodities pared early losses along with equities, with copper steady around $7,175 a tonne and benchmark London Brent crude steady below $69 a barrel before weekly U.S. inventories data expected to show a rise in gasoline supplies.
The strong dollar pushed gold to near a three-month low around $646 an ounce.