European Markets Stabilize But Investors Still Jittery -- 3rd Update

By Josie Cox 

European markets showed signs of stabilizing after several sessions of declines Thursday, but investors remained on edge.

Having slumped to a two-month low early in the day, the Stoxx Europe 600 recovered to trade around 0.1% lower by midafternoon.

Individual country indexes also reduced earlier losses, and bond markets recovered too, but investors said that the next few days and weeks would likely remain highly volatile and that it was too early to call an end to the rout.

"The start of the year saw some very one-way trades," said David Vickers, a senior portfolio manager at London-based Russell Investments, adding that this has made several asset classes susceptible to big turnarounds.

"Markets are very interconnected at the moment and there is a general fear lurking that this big snapback we're seeing in bond markets will unravel equity markets too," he said. "It's a bit like a domino effect."

European stock and bond markets rallied strongly earlier this year, largely as a result of the European Central Bank's quantitative-easing program, but changed direction last week and have continued to sell off since.

Late Wednesday, U.S. Federal Reserve Chairwoman Janet Yellen added to jitters when she suggested the yearslong stock rally may have driven prices too high and exposed debt investors to too much risk.

The yield on the German 10-year bond, or Bund, rose to a more than five-month high of 0.78% early Thursday, having hit an all-time low of 0.05% less than three weeks ago. Later in the day it retraced to around 0.6%.

Many strategists and investors had last week dismissed the reversal in markets as a passing blip, and were caught off guard by the scope of this week's moves.

"This isn't just a market shakeout," said Justin Knight, head of European rates strategy at UBS. For some weeks, Mr. Knight had been saying that bond yields were at unsustainably low levels, but on Thursday he said he was surprised at the speed of the reversal.

Bill Eigen, a fund manager at J.P. Morgan Funds, meanwhile, said that this is the "most volatile market since the 2013 taper tantrum," when the Fed indicated it could start reducing its bond-buying program.

"Investors would be wise to focus on stability, reducing the likelihood of capital losses and preserving capital," he said.

On Wall Street, the S&P 500 was steady in early trade.

The Chicago Board Options Exchange Volatility Index, or VIX--commonly considered a proxy for the U.S. stock market's capacity for sudden spikes and plunges, has risen 4% so far in May.

In currency markets, the euro was trading 0.6% lower against the dollar midafternoon--at just above $1.12--having hit a two-month high early in the session.

Elsewhere, the British pound fell around 0.2% to a three-month low against the euro as polls opened for one of the most closely fought elections in recent U.K. history. Sterling also edged lower against a weak U.S. dollar.

Although the pound has shown resilience in the lead-up to the vote, strategists on Thursday said the currency would likely face headwinds over the coming days, especially if no single party is able to secure a majority, which could lead to lengthy negotiations over a possible coalition.

"If heightened uncertainty weighs more heavily on the pound in the near term, it could create an attractive opportunity to buy the pound on dips, " said Lee Hardman, a strategist at Bank of Tokyo-Mitsubishi UFJ.

London's FTSE 100 index was 0.6% lower by midafternoon, though strategists said that this was also likely a symptom of the global market moves rather than of domestic politics.

The yield on the U.K.'s 10-year gilt was recently just under 2%. On Wednesday, it surpassed the 2% mark for the first time since December.

--Tommy Stubbington contributed to this article

Write to Josie Cox at [e-mail]

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