US
Brent crude oil prices retreated after yesterday’s surged to their highest level since May 20, helping steady the selloff in stocks and bonds. However, Iran has every incentive to keep the heat on ahead of the November 3 midterms and hurt Republicans. As such, any relief pullback in crude oil prices is likely to be shallow and short-lived.
Nonetheless, the bond rout is becoming self-limiting. The 10-year Treasury yields near 5% stand more than 1% above the S&P 500 trailing earnings yield, leaving investors poorly compensated for taking equity risks. An increasingly negative equity risk premium should encourage a rotation into bonds and ultimately cap the selloff. Higher bond yields also tighten financial conditions, and weigh on the growth outlook, which should help pull real yields lower.
USD is holding on to yesterday’s gains, triggered by oil-driven risk aversion and a brief hawkish Fed repricing after the US August PPI. PPI was broadly in line with expectations, but a few components feeding into PCE ran hot. Airline passenger services jumped 4.2% m/m vs. -3.1% in July, the sharpest rise since December 2024, while hospital care also firmed. Still, PPI Services less Trade, Transportation, and Warehousing, points to softer PCE inflation.
Regardless, today’s pivotal August CPI report will be the main arbiter of next week’s Fed decision. Fed funds futures price in 68% odds of a 25bps hike to 3.75-4.00% on September 16. Fed Chair Kevin Warsh noted in his August Jackson Hole speech that he welcomed this summer’s better than expected PCE and CPI readings but cautioned “they do not tell me that underlying trends have meaningfully improved.”
As such, a hot CPI print would all but seal a September hike and underpin a firmer USD. A cooler reading would strengthen the case for a hold and leave USD vulnerable to a dovish Fed repricing. More importantly, even if a September Fed hike becomes a done deal, we doubt USD will make new cyclical highs because tightening by other major central banks limits policy divergence.
Headline CPI is expected to rise +0.4% m/m vs. 0.1% in July on higher gasoline prices and remain at 3.4% y/y for a second straight month. Core CPI is expected to rise +0.2% m/m vs. 0.2% in July and ease to 2.4% y/y vs. 2.5% in July. That would match the Cleveland Fed’s CPI inflation forecasts.
The three-month annualized CPI change will indicate whether inflation momentum continues to decelerate while CPI measures which filter out extreme price swings (trimmed, sticky, median, and super core) will be key to judging if the improvement in underlying inflation is stalling or reversing.
Risks around the US August CPI print are finely balanced, setting the stage for an exceptionally volatile market reaction. The August pick-up in the ISM Prices Paid index suggests upside inflation risks have yet to recede. However, the continued slowdown in US average hourly earnings growth in August remains an important disinflationary force.
UK
GBP/USD is trading on the defensive near 1.3500, with the next major support offered at the 200-day moving average (1.3453). UK real GDP beat expectations in July. Real GDP unexpectedly increased 0.4% m/m (consensus: 0.0%) vs. 0.3% in June driven by services (+0.4% m/m), production (+0.2% m/m), and construction (+0.1% m/m).
Real GDP is tracking above the Bank of England’s (BOE) baseline Q3 forecast of 0.1% q/q, but that does not justify the swaps curve pricing in a full 100bps of BOE rate hikes in the next twelve months to 4.75%.
The UK’s negative output gap, a policy rate already near the top end of the BOE’s 2.00% to 4.00% neutral range estimate and the prospect of tighter fiscal policy all argue for a less aggressive hiking cycle. Bottom line: GBP is vulnerable to a dovish BOE repricing.
EUROZONE
EUR/USD is trading heavy around 1.1600. The ECB delivered a hawkish hike yesterday. As was widely expected, the ECB raised the policy rate 25bps to 2.50%. ECB President Christine Lagarde said the decision was unanimous and a “no brainer.” Importantly, the ECB signaled more hikes are in the pipeline noting that “inflation is set to remain well above target for an extended period”, while highlighting the greater resilience of the Eurozone economy.
Specifically, the ECB revised its baseline inflation projection higher for 2027 and 2028, while 2026 was unchanged. Baseline projection for real GDP growth was revised higher for both 2026 and 2027, while 2028 was unchanged. The ECB also cautioned “the outlook remains highly uncertain, with risks to the upside for inflation and to the downside for economic growth.”
Overall, the ECB is on track to bring the policy rate closer to the upper end of its 1.75%-3.00% neutral range. The swaps curve is more aggressive and implies ECB rates at 3.50% in the next twelve months. Bottom line: EU-US rate differentials remain broadly supportive for EUR/USD.
