Yields Continue Higher

MACRO FRAME

US economic data this week (PMI, payrolls), paired with a host of Fed speakers is likely to significantly shape the near-term outlook for the Fed.

STOCK INDEX FUTURES

Equity index futures moved modestly higher overnight, led by technology and consulting names. Micron’s better-than-expected revenue outlook and $32 billion of customer commitments reinforced the view that AI-related memory demand and infrastructure spending remain resilient. The positive read-through extended to the semiconductor complex. The 10-year Treasury yield reached 5.342% overnight; heavy AI-related infrastructure investment is evidence that growth and capital demand may remain firmer for longer, reinforcing the case for elevated rates rather than an imminent easing cycle. While stronger AI investment supports earnings expectations, it also risks capital-expenditure demand, financing needs, and inflation persistence—factors that may keep long-end yields under upward pressure and make investors weary on a company-specific basis. Wednesday’s softer-than-expected inflation data led markets to pare near-term expectations of a rate increase, with Fed funds futures assigning a 63% probability to no change at the upcoming meeting. The market will scrutinize comments from Thomas Barkin, Christopher Waller, Philip Jefferson, Michelle Bowman, and Lorie Logan for guidance on whether officials see the recent inflation moderation as durable or simply insufficient to change the broader restrictive-policy stance.

Watch point: Despite tech volatility, the earnings backdrop suggests bullishness, despite the advent of a new hiking cycle.

CURRENCIES

US DOLLAR: The USD index rose 0.35% to 101.80. Despite yesterday’s softer-than-expected inflation data and reduction in near-term tightening odds, the dollar moved higher into today’s session. While dollar strength can be attributed to strong US growth indications, higher Treasury yields, and a hawkish Fed, strength is also coming from a weaker euro. Today’s main events for the dollar are several Fed speakers and ISM’s manufacturing PMI survey. Hawkish comments and a strong reading are likely to add to near-term tightening odds, though would likely require very strong readings to recover the same pricing odds the market held before today’s release. That leaves September’s PCE reading next month as the next big inflation release for the Fed, which gives markets and Fed members plenty of time to digest ongoing geopolitical dynamics and assess other economic data.

Watch point: A reduction in tightening expectations for the Fed will act as the greatest risk to the dollar maintain its move above the 100 level.

EURO: The euro fell 0.38% to $1.1286. The euro is lower not only against the dollar, but also against the yen and Swiss franc, while only narrowly holding positive territory against sterling. This broad-based underperformance indicates that the move is not purely a USD story; it reflects a distinct European risk premium. A combination of higher energy prices, renewed euro-area inflation pressure, rising sovereign yields, and political uncertainty are the main catalysts weighing on the currency. French government yields reached another 14-year high amid concerns about fiscal sustainability, while German bunds also sold off. Meanwhile, yesterday’s inflation data showed a surge across the currency bloc, though core readings were relatively stable, which has lead money markets to reduce expectations of an October hike to 33%, putting it in-line with Fed pricing.

Watch point: Broader price direction will be subject to Fed-ECB policy expectations, which has been favorable to the dollar in advent of a hawkish repricing in Fed policy expectations the near-term.

BRITISH POUND: Sterling fell 0.35% to $1.3219 to a three-month low. Revised Q2 GDP data revealed the economy grew faster than previously expected in the second quarter. GDP rose 0.5%, a modestly higher than the initial estimate of 0.4%. Still, despite the growth, money market remain overly hawkish in our opinion. Money markets are priced for 100 bps of tightening over the next 10 months from the BoE. However, that pricing appears at odds with current economic conditions in the country, which will limit the central bank from tightening rates as aggressively as markets expect.

JAPANESE YEN: The yen fell 0.10% to 158.03 yen per dollar. The summary of opinions from the Bank of Japan’s September provided little clarity on the timing of a potential rate hike ahead of policy meetings in October and December. However, the minutes did point to a board more favorable to raising rates once more. Meanwhile, the BOJ’s quarterly Tankan showed manufacturing sentiment improved to its highest level in eight years, while overall business conditions reached their most favorable levels in decades. Sentiment regarding the currency has been damaged after the BOJ underwhelmed the investors following its divided decision to raise rates and Governor Ueda’s unconvincing press conference at the meeting. The greatest near-term upside risk for the currency remains market intervention. Markets are pricing roughly a 23% chance of a hike in October and see 21 bps of tightening by year-end.

Watch point: While markets are underwhelmed at the BOJ, a path for additional rate hikes looks to be  appears to be the primary scenario.

AUSTRALIAN DOLLAR: The Aussie is little changed at $0.6947. Monthly inflation data came in just under forecasts and led markets to further reduce odds of a near-term rate hike. CPI rose 0.4% m/m in August, under forecasts got 0.5%. The trimmed mean measure of core inflation rose 0.2% in August, under forecasts of 0.3%, though the annual pace held at 3.6% for a third straight month. This follows the Reserve Bank of Australia’s decision to raise rates by 25 bps to 4.60%. The board unanimously voted to raise its cash rate, the fourth hike this year. RBA Governor Bullock said the board believed financial conditions were now tight but were unsure if that would be enough to bring inflation down. She also noted policy worked with a lag and the board wanted to see how the hikes already delivered would impact the economy, a signal markets took as a potential end to further tightening. Bullock referenced that inflation data will play the greatest role in determining where policy lands in the future.

Watch point: August’s hiring figures argue for a higher-for-longer stance, leading the focus to Q3’s inflation data.

TREASURY FUTURES

Yields moved lower at the front end and higher at the long end, with the 10-year yield hitting 5.34% overnight. While core PCE came in lower than the consensus the reading was dragged lower by changes in how the number was calculated, a factor which the market already understood. A raft of Fed speakers and ISM’s PMI survey will dictate yield direction, particularly at the front-end if policymakers offer hawkish remarks and the PMI gauge shows strong business activity. While yesterday’s softer core reading has eased immediate concern that inflation is reaccelerating consumer spending remained notably firm, rising 0.9% m/m and real PCE gained 0.6%, following a weak July. Meanwhile, the accompanying GDP revisions further strengthen the case for tighter policy. Q2 real GDP was revised up to 2.2% annualized, while real final sales to private domestic purchasers were revised to a robust 4.6%. The latter measure, capturing consumer spending and private fixed investment, suggests underlying domestic demand was considerably stronger than the headline GDP figure alone implies.

Watch point: Inflation risk, fiscal and corporate supply, capital competition and term premium will be key factors in determining whether the yield curve maintains its recent flattening or falls into a bear steeping move.

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