It’s been a rough week for stocks and even more so for bonds. A rout in sovereign debt picked up pace on Thursday as bond yields struck fresh cycle highs as oil prices surged and the European Central Bank hiked and appeared ready to do more. European stock markets are on track for their worst week since April after hitting two-month lows on Thursday. The FTSE 100 fell for a fifth straight session and closed at its lowest since late July. Wall Street also fell with the S&P 500 and Dow both down 0.6 per cent, while the Nasdaq 100 fell 1.1 per cent. It was the fourth straight daily decline for the S&P 500. Both the S&P 500 and Nasdaq are headed for a 1.6 per cent slide for the week, while the Dow is on course for a 2.5 per cent weekly decline. Sentiment has picked up a touch early Friday amid reports of a possible deal to ease the problems in the energy complex but risk appetite remains subdued. September is always like this.
Crude prices have retreated slightly this morning on reports Iran and Gulf states will meet in a push to reopen the Strait of Hormuz. Brent crude dipped about 4 per cent off its highs to find support at the past resistance level of $105. But focusing on crude prices alone is misleading – you don’t fill your car or tractor with crude oil. Worryingly, with crack spreads blowing out US diesel prices hit a record high above $6 a gallon.
With oil trading down a touch there is some reprieve for bonds and stocks in Europe, which climbed early Friday morning. Gains were modest with the FTSE 100 up 0.3 per cent, the Dax up a similar amount and the CAC adding 0.6 per cent. It follows a relatively weak handover from Asia, led by declines for Taiwan, Korea and Japan. SK Hynix and Samsung Electronics were among the biggest decliners after China’s DeepSeek said it managed to reduce the amount of high-bandwidth memory needed for its latest model. US futures are trading a touch higher.
The bond market is like a toddler; it needs to test the limits and it throws the occasional tantrum. Yesterday was one of those tantrums. Sentiment hinges both on events in the Middle East and on the US inflation report later today. Odds of a Fed rate hike next week have risen from 60 per cent to 70 per cent, but as the CPI report will dictate assumptions (based on recent Fed speak), we could see another considerable move of size in front-end rates today.
To my mind, the single biggest risk to the market now is if the Fed doesn’t hike – even if the CPI ‘justifies’ a hold, not raising rates now would see a further blow-out in long-term yields that would force the Treasury to intervene further. Would increasing buybacks significantly look to Mr Market like there is something wrong and the government is worried – a reason to sell bonds – or would it be enough to show intent to ‘do whatever it takes’ a la Mario Draghi? We should note that there was strong demand at last night’s 30-year auction.
US CPI inflation is the big test today and just a small shift in the reading could alter the picture for the Fed. It’s got itself in a position where, because of a lack of forward guidance and chair Kevin Warsh’s unwillingness to detail what might trigger a change, the market is filling in the blanks. But it could be way out. Leaving aside why Fed officials can be swayed by a 0.1 percentage point difference for a single month after more than five and a half years of above-target readings, it nevertheless means there is an unusually high degree of uncertainty and risk associated with this event.
By Neil Wilson, investor strategist at Saxo UK