Expectations for a Fed pause rewind

Talk about volatility.

After Friday's weak US jobs number raised expectations of a pause in Fed tightening, one speech by Chairman Ben Bernanke yesterday changed everything. From Reuters:

The U.S. Federal Reserve needs to be vigilant to make sure inflation stays under control even as the U.S. economy starts to shift to a slower pace of growth, Fed Chairman Ben Bernanke said on Monday...

While welcoming signs of cooler growth, the U.S. central bank chief stressed concerns over core inflation, saying it had reached levels that "if sustained" would put it at or above the upper end of the range consistent with price stability...

Financial markets saw the comments as suggesting the Fed was likely to raise benchmark overnight interest rates for a 17th consecutive time at its upcoming meeting on June 28-29.

The blue chip Dow Jones industrial average closed off nearly 200 points, or 1.77 percent, at 11,048.72 as investors braced for higher credit costs. Prices for U.S. government bonds also fell, while the dollar strengthened.

Bets in interest rate futures markets pushed chances of a quarter-percentage point June rate hike, which would take the key federal funds rate to 5.25 percent, up to 76 percent. The probability of a move stood at just 48 percent on Friday.

Yesterday's ISM report on the service sector tells the same story of slowing growth but higher inflation. Again from Reuters:

The Institute for Supply Management's services index eased to 60.1 in May, in line with forecasts and down from 63.0 in April...

The survey's prices-paid index spiked to 77.5 from 70.5. That was its highest since September, when Hurricane Katrina caused a huge jump in energy costs, and comes at a time when investors are watching inflation closely to gauge whether the Federal Reserve will keep raising interest rates.

In the UK, the service sector also slowed, albeit slightly.

The Chartered Institute of Purchasing and Supply/RBS business activity index, which is closely watched by the Bank of England's Monetary Policy Committee, eased to 59.2 in May from the two-year high of 59.7 struck in April.