A look at the day ahead in U.S. and global markets from Mike Dolan

A volte face in Treasury yields has improved investors’ mood considerably this week as excitement about U.S. disinflation builds despite conflicting signals from around the world.

After bumpy start to the third quarter, stocks and bonds rallied together on Monday – with both two- and 10-year Treasury yields recoiling sharply back below 5% and 4% thresholds respectively.

Spurred by more signs of ebbing U.S. inflation ahead of Wednesday’s critical June consumer price report, Wall Street stocks also recovered ground on Monday.

U.S. small cap stocks led the way, with the Russell 2000 jumping 1.6% to clock its best day in more than a month – ahead of both the NFIB June small business survey later on Tuesday and the onset of the second-quarter earnings season.

S&P 500 futures held Monday’s modest index gains overnight.

But the roots of the rally were in the bond market, where benchmark government borrowing rates fell back despite little change in Federal Reserve policy thinking or even market pricing of Fed moves this year. The dollar retreated sharply too, most notably against Japan’s yen.

While some of that bond repricing may have been positioning for Wednesday’s release of an expected near one percentage point drop in U.S. headline CPI inflation to just 3.1% in June, there were numerous other background factors.

A New York Fed survey showed on Monday that household inflation expectations for the year ahead fell to 3.8% last month, the lowest in more than two years. The Fed also reported that consumer credit plunged to $7.1 billion in May, less than a third of the previous month and less than half forecast.

On top of that, markets also focused on a reported 4.2% drop in used-vehicle prices last month – the biggest drop since the pandemic hit and a price category that had been a big aggravator of the recent inflation spike.

A slew of speeches from Fed officials seemed less accommodating – with most advocating at least one more rate hike in the current cycle. But there was also a sense that policy tightening was in the last lap.

And if bond markets were looking for another reason to rebound at the margin, the Fed’s top regulatory official Michael Barr laid out a sweeping plan to increase capital requirements for the largest U.S. banks in the wake of recent bank failures, a move met with criticism from the industry.

But if the U.S. inflation picture is looking more optimistic, it’s much harder to read around the world.

After China showed on Monday that it was flirting with outright deflation last month, Britain relayed a screed of mixed signals – accelerating wage growth to match record highs, rising unemployment, mortgage rates soaring to 15-year highs and the Bank of England talking tough on more policy tightening.

The net effect was to see two-year UK gilt yields fall in tandem with Treasuries, UK mid-cap stocks advance and sterling rise to its highest in a year against the retreating dollar.

China and Hong Kong stocks and the yuan were more upbeat as signs of some government support for the stuttering economy emerged. China’s central bank on Monday extended a rescue package to shore up the real estate sector and there were hopes the long-running tech sector crackdown was coming to an end.

Events to watch for later on Tuesday:

* U.S. June NFIB small business survey, June employment trends

* New York Federal Reserve President John Williams speaks

* U.S. President Joe Biden arrives in Vilnius for NATO summit

* U.S. Treasury auctions 3-year notes, 12-month bills

(By Mike Dolan, editing by Jane Merriman,; mike.dolan@thomsonreuters.com. Twitter: @reutersMikeD)

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