Nick Spencer-Skeen, Senior Executive Officer, Lunaro Markets Limited
Friday Closing Prices
- S&P 500 7,657 (+0.86%)
- Nasdaq 26,333 (+0.96%)
- Gold $4,349 (+0.75%)
- Brent Crude Oil $104.35 (-4.20%)
Last week, our title ‘The Fed Hike Is Back On The Table’ was apt, with Friday’s data reinforcing that view as hotter US inflation and another surge in oil prices combined to push expectations of an imminent interest rate hike from the Federal Reserve (Fed) higher.
Friday’s August Consumer Price Index (CPI) release was the key event, with core inflation rising 0.3% month-on-month and the Producer Price Index (PPI) also printing firmly. The data reinforced concerns that inflation remains too persistent for the Fed to ignore, with futures contracts pricing in a high probability of a 0.25% hike for this week’s FOMC meeting. Treasury yields rose across the curve, with the 10-year approaching 5%, although longer-dated bonds recovered somewhat on Friday as investors judged that further tightening would ultimately weigh on growth.
The European Central Bank (ECB) had already added to the hawkish backdrop, raising its deposit rate by 0.25% to 2.5% on Thursday. More than that, it signalled that further tightening remains possible, including as soon as October.
Oil led the cross-asset moves, which we cover in more detail below. Brent surged to highs just under $110 as escalating attacks around the Strait of Hormuz intensified concerns over global energy supply.
Global stocks struggled under the combined pressure. The S&P 500 fell on the week, while European and Asian markets underperformed. Gold declined 1.7% as rising real yields outweighed inflation-hedge demand, while the US dollar was broadly unchanged.
Oil Above $100
Oil prices popped last week as the Middle East conflict increasingly translated into a physical supply problem. Both Brent and WTI rose above $100 per barrel after a sharp increase in attacks on tankers and energy infrastructure around the Strait of Hormuz.
Reduced vessel traffic through the key shipping route, alongside disruption to alternative export corridors, intensified fears that Gulf supply could remain constrained for longer.
Those risks increased further into the weekend after Saudi Arabia temporarily shut its East-West pipeline following a drone attack. Further, an Iran-Oman understanding offered no immediate reopening of Hormuz.
So as we enter the new week, it leaves oil trading with a sizeable geopolitical premium. Diplomatic progress could trigger a sharp reversal, but absent credible improvement in shipping security, it could keep Brent supported above $100. Traders also need to watch oil for the inflationary consequences, which can spill over into other asset classes.
Warsh’s First Hike?
The Fed meets this week, with markets increasing pricing in the possibility that Kevin Warsh could deliver the first rate hike since 2023. As our chart of the week shows, futures markets have been increasing the probability of this happening in recent weeks. A 0.25% increase would take the target range to 3.75%-4.00%.
The case for tightening strengthened materially late last week due to the inflation print. It’s true that the backdrop is complicated by a still-resilient labour market. Although this gives policymakers greater scope to lean against the need for several future rate hikes, in the short-term may not be enough to keep the committee on hold.
The decision itself may now be less important than Warsh’s guidance. The test of whether it’s an insurance hike versus more tightening needed is likely to drive the knee-jerk reaction in markets. A hawkish message would likely pressure equities and front-end Treasuries, while a more cautious signal could help gold to rally.
Bonds Under Pressure
An ongoing barometer for traders to watch this week is global bond yields. Last week, Germany’s 10-year yield reached its highest level since 2011, while US and UK yields also climbed to levels not seen for decades2.
We have already run through most of the catalysts behind the move, including a renewed inflation shock and the prospect of tighter monetary policy across major economies. Yet at its core, the move arguably reflects a broader reassessment of where neutral rates ultimately settle.
If we do see persistent inflation, heavy government borrowing, and higher energy prices going forward, it really challenges the case for lower yields.
Even for those who don’t actively trade bonds, noting this week’s yield move in response to the Fed meeting and oil movements can provide a useful pulse on sentiment in a key market.
