Rate-Hike Alert and Rising Yields Dominate the Week

Markets are now firmly on rate-hike alert for this month following Fed Chairman Kevin Warsh’s inflation-fighting rhetoric at Jackson Hole last week. The odds of a September rate increase have pushed to around 70%, up from around 35% before his speech. Between now and the Fed’s September 15-16 meeting, two key data releases will heavily influence the path of interest rates: Non-Farm Payrolls (NFP) on Friday and CPI next week. Any downside surprises in either print could shift the odds back toward a hold, while upside beats would increase pressure on Warsh to back up his tough talk on inflation with actual action. Consensus estimates currently point to a +55k rise in Friday’s NFP figure, a rebound from the dismal –23k reading in the prior month. It also remains an open question whether Warsh is prepared to hike rates in the face of what is arguably a supply-side driven inflation shock, with elevated oil prices sitting at the heart of the dilemma.

Oil prices have taken off this week in tandem with the resumption of US military strikes on Iran. The renewed action has brought the threat of Iranian retaliation back into focus, along with the associated risks to energy infrastructure around the Gulf and shipping through the Strait of Hormuz. That combination has re-introduced a fresh dose of risk premium into the market. Both Brent and WTI have traded above the $90 level this week, and a return toward $100 oil cannot be ruled out if the current escalatory phase continues.

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Along with oil’s ascent, rising global bond yields have emerged as the dominant story in financial markets this week. The bond-market sell-off is multi-faceted, with inflation concerns linked to high oil prices and broader debt-and-deficit worries the most likely drivers. Investors are demanding a higher term premium to compensate for two major risks: sticky energy-driven inflation on one side, and relentless government debt issuance on the other. Higher global yields do not bode well for economic growth or corporate earnings, making it difficult to envisage a scenario in which risk assets can comfortably rise alongside runaway bond yields. It is reasonable to assume the US administration is far from comfortable with the current bond-market picture, raising the possibility of further intervention aimed at taming yields.

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The US Dollar has enjoyed a return to form on the back of higher oil, rising Treasury yields and growing anticipation of a Fed rate hike. The Dollar Index (DXY) has moved past the 99.70 level as a result. In theory, rising yields tend to support a country’s currency. That relationship is not holding in Japan, even after the 10-year JGB yield hit 3% for the first time in 30 years. The link between rising yields and a stronger currency is broken because the move is being driven by the wrong factors. Japanese yields are climbing due to sticky inflation and fiscal supply worries rather than rapid, credible policy tightening. With real rates still negative and the US yield spread remaining wide, higher JGB yields reflect a rising risk premium rather than a magnet for foreign capital. We have already noted the potential for further US bond-market intervention; if the USD/JPY rate continues to push toward the 163–164 zone, another round of currency intervention to support the yen may also arrive.

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Gold prices have come back to earth this week. The precious metal has been bruised by Warsh’s hawkish tone, a stronger Dollar, rising yields and higher oil. A soft NFP print on Friday that takes some momentum out of the Dollar and yields could open a rebound window for gold. Conversely, strong jobs numbers would likely extend the recent pressure. Technical levels to watch include support at $4,300, $4,255 and further out at $4,115, while resistance awaits at $4,450 and $4,530.