Sive Morten
Special Consultant to the FPA
- Messages
- 22,091
FUNDAMENTALS
This week has passed under the sign of the Fed. It starts acting again and markets now think about the major plan that the Fed and US Treasury are trying to realize. So, the balance of the Fed and ECB policy is changing now. ECB showed no clarity about further steps while the Fed has given a hint on another rate change in 2026. As a result, long term rates stand above their historical level in all G7 countries and nobody surprised with it. Now it is a big concern where this road will lead us. Meantime, next week flash purchasing managers index (PMI) data from the US manufacturing sector landing will give the growling global bond markets something to chew on.
MARKET OVERVIEW
Rising bets on rate hikes around the world have pushed bond yields to multi-year or multi-decade highs in the U.S., Europe and Japan. So far the effect on the FX market has been relatively limited, as yields have largely moved in tandem. The prospect of a new global interest rate-tightening cycle is coming into view as some of the world's top central banks raise rates and signal more may be needed to tame inflation fuelled by the Iran war.
Key rates are already much higher than the rock-bottom levels from the last hiking cycle that began in 2022. But central bankers are under market pressure to show that they are prepared to raise them further to tame inflation expectations and rein in long-term bond yields at multidecade highs. The moves, while formally independent of each other, reflect a shared concern among policymakers that higher oil and gas costs resulting from the Iran war raise the spectre of a new cost-of-living squeeze just a few years after the inflation surge that followed the COVID-19 pandemic.
The dollar jumped against the yen on Friday after two policymakers at the Bank of Japan dissented from a widely expected decision to raise interest rates, raising doubt among traders about the likelihood of further hikes. The BOJ pushed rates to their highest level in 31 years at 1.25%, yet the move did not boost the Japanese currency as traders felt there was a lack of explicitly hawkish guidance. The decision, coming on the heels of the Fed's hawkish message from earlier this week, clears the way for further dollar strength, strategists said.
The dollar index, which tracks the currency against six major peers, was up 1.2% for the week to around a seven-week high after the US Federal Reserve hiked interest rates on Wednesday and signalled more increases could be coming. Traders see a roughly 55% chance of a quarter-point hike at the Fed's next two-day meeting next month, up from 27% a week ago, according to the CME Group's FedWatch tool.
The Fed's unanimous decision to raise rates, coupled with Warsh's comments on Wednesday, were seen as laying the groundwork for further tightening and helped reassure investors about the central bank's commitment to fighting inflation. The Fed's new policy statement and economic projections show a central bank opening the door to tighter monetary policy through next year, with the policy rate rising to the 4.00%-4.25% range by the end of this year and ending 2027 at the same level.
Though the Fed may have delivered on the market's hawkish expectations for now, it might still not raise rates as aggressively as the market expects, making the dollar vulnerable to any disappointment. Markets remain far more hawkish than the Fed. While policymakers project one more rate hike in 2026 and a hold in 2027, investors are pricing in more than one additional increase this year and roughly three more by the end of 2027.
Goldman Sachs expects the US Federal Reserve to raise interest rates again in October after policymakers signaled they may need to tighten further to bring inflation back to target. The brokerage forecast a 25-basis-point increase at the Fed's October meeting. Morgan Stanley and Australia's Macquarie also added a March 2027 rate hike to their existing forecasts for a December increase. The Fed's projections pointed to further tightening, with a 16-2 majority of officials expecting at least one more hike this year and four policymakers forecasting two additional increases.
Goldman said policymakers increasingly favored a quicker return of inflation to the Fed's 2% target, making October the most likely opening for the next move. The analysts inferred from the Fed's messaging that officials could favour consecutive rate increases rather than a more gradual approach.
The shift comes as markets increasingly embrace a "higher-for-longer" interest-rate outlook. Oil prices have climbed above $100 a barrel, adding to concerns that inflation pressures could remain persistent, while recent economic data have pointed to continued resilience in growth. Goldman's revised forecast brings it in line with a growing number of brokerages expecting further tightening from the Fed. Bank of America Global Research has the most hawkish outlook, projecting rate hikes in both October and December.
Economists polled by Reuters also expect at least one more hike by the end of March, reversing a fragile no-change consensus prior to Friday's official data showing firm inflation.
Euro zone wage growth continued to slow last quarter even as inflation picked up, and negotiated wage contracts point to only a mild pickup next year, offering European Central Bank policymakers comfort that price growth remains under control. The annual increase in labour costs slowed to 3.1% in the second quarter from 3.3% three months earlier. Euro zone inflation stood at 3.3% in August and the ECB expects it to rise further in the coming months.
Investors have been ramping up their expectations for ECB rate hikes since the euro zone's central bank increased borrowing costs last week as a widening conflict in the Middle East pushed up the cost of fuel for the bloc. Vujcic, ECB vice-president, said persistently high energy prices would not only push up inflation but could also weaken economic growth by squeezing household incomes and spending.
Money markets price another three or four hikes by the end of next year, with the next one possibly coming as soon as October. That would raise the deposit rate to 3.25% or 3.50%. The ECB has described a rate of more than 2.50% as restrictive, that is curbing economic growth. Two sources told Reuters last week that further tightening was now on the cards. While a hike at the next meeting in October could be in play, a move in December — which would be the ECB's third hike this year — is more likely.
The European Central Bank may need to gradually raise interest rates further to curb inflation before an Iran war-driven rise in fuel costs starts seeping through to wages and other prices, ECB policymaker Martins Kazaks told Reuters. Kazaks argued inflation, which the ECB puts at 3.6% in the last quarter of this year, was still in the "inattention area" for consumers and businesses, but this may change if staples such as fuel and food become even more expensive.
While European Central Bank policymaker Olli Rehn said on Thursday there were no clear signs of second-round inflation effects in the euro zone and backed the use of jointly-issued debt for strengthening the region's defence capabilities.
WEEKLY COMMENTS
So, Someone will be very unhappy. All 12 members of the FOMC voted in favor of tightening policy. This is the first rate hike under the leadership of the new Fed Chairman, Kevin Warsh. The updated dot plot from the Federal Reserve showed that the median forecast of officials anticipates another rate hike by the end of 2026.
16 participants called for one additional rate hike, while 4 participants called for two rate hikes this year.
The Federal Reserve's forecasts for the interest rate have increased to 4.1% in 2026 and 4.1% in 2027, meaning they anticipate another rate hike and a prolonged period of high rates. After that, the rate will only return to pre-current-hike levels by 2029. The forecast for the long-term interest rate has increased to 3.2% and is likely to increase further. However, this means that Trump should not expect "the lowest" interest rates. Only four expect a rate cut in 2027, while eight expect it to be at 4.25%-4.5%, i.e., +50 basis points from the current level.
It seems that the US financial authorities have decided to go through this short path of meaningless decisions, hoping for a miracle. Well, it's a choice – the effort itself is a pleasure. The only thing that Warsh achieved with this move is to demonstrate the Fed's independence from Trump. He saved face, so to speak. But the market frankly doesn't care what face anyone puts on.
The Fed understands: that the fact that they made a completely meaningless decision about a symbolic interest rate hike will not cause investors to rush to buy Treasury bonds. But that's the way the game is played now – the Fed, as it were, doesn't lose the market's trust (because they didn't give in to Trump), and investors... continue to gradually sell US debt (in fact, after the Fed's verdict was announced, the yield on 10-year Treasury bonds began to rise again).
It's hard to say how much time they have left. They might still have time to make one more such pointless decision before the AI bubble bursts. And there's no longer any doubt that it's about to happen, because all the major players in the American AI industry have suddenly, in a united chorus, demonstrated unprecedented concern for the fate of all mankind, stating the need to "slow down" the development of AI. They've taken the lead, as it were.
And when the AI bubble starts to burst, the Fed will finally have a formal reason to make the inevitable, albeit terrible for the dollar, decision – to launch a mega-QE program. The conspiracy theorist deep inside me thinks that this choral performance of a serenade from Silicon Valley is no coincidence. The AI leaders, like the US Treasury, also need those life-saving funds.
Now, pay attention to what's happening:
Warsh is raising interest rates. The interest rates that the Treasury pays on bonds are increasing. Bessent holds Long-end yields low (or trying to). The amount of money the government is paying to creditors is growing. These creditors, mostly institutions, are either parking the increased funds in speculative bubbles or paying it out to their clients. These clients are primarily baby boomer pensioners, whose propensity to consume is approaching to 100%. The amount of money in the economy is growing faster than the economy itself, leading to inflation. Three months later, Warsh looks at the data and raises interest rates again.
And this scenario seems reasonable if we take a look at big divergence among sentiment and consumption. Here's another economic WTF moment. In August, Americans suddenly started spending money. Retail sales rose by 1.2% month-over-month – the highest since March, and up 6% year-over-year. So, based on actual spending, the picture looks like the American consumer is very much alive, and even thriving. And now, the most interesting part.
Consumer sentiment is at historically low levels. This creates a fascinating paradox in the American economy - Sentiment is almost as low as during COVID, while Spending is at record levels. Meanwhile, the actual sales data paints a completely different picture. However, this doesn't necessarily mean that the consumer is healthy. Retail sales are measured in nominal dollars, and inflation itself inflates the numbers.
In July, the United States experienced a net capital outflow of $28 billion, the first in 15 months. Foreign investors did not invest in U.S. government bonds (-$3.6 billion), although they bought other bonds (+$40.5 billion). The inflow into stocks was almost zero (+$3.7 billion), while there was a significant outflow from the U.S. into foreign stocks and bonds (-$68.5 billion). Over the three months, only $59 billion flowed into U.S. government debt, and almost all of that was in May. In June and July, it was practically impossible to attract foreign capital into U.S. government debt - the inflow was less than $3 billion.
Interest payments on the national debt, Social Security, Medicare, healthcare, and veteran benefits are now consuming 98.4% of all federal revenue – almost a record. Since 2022, this figure has increased by 28 percentage points. Meanwhile, interest expenses alone have reached a record 19.7% of the budget's revenue. In other words, virtually every dollar coming into the federal budget is now being used for mandatory expenses and debt servicing. Is there a long-term plan? The question is rhetorical.
Meantime, Currently, there are approximately $7.0 trillion worth of Treasury bills outstanding, with roughly $6.1 trillion of these securities maturing within the next year. Taking into account other obligations, approximately $7.5 trillion of marketable Treasury debt is due to mature in 2026. The US is facing a massive wave of refinancing against a backdrop of rising borrowing costs.
Bank of America strategists argue that the greater risk now is not volatility, but complacency. The yield on 30-year Treasury bonds has reached its highest level since June 2007, and commodity prices are rising sharply, yet "there is no panic anywhere" in the markets, according to a research note from strategists led by Jared Woodard. Turning to the central banks, it's already clear that the global tightening cycle [policy error] will continue one way or another.
CONCLUSION:
It is difficult to say what the shape of the coming Fed's cycle will be, but the one thing we could say definitely - the national debt structure is coming to the breaking point. This makes US Treasury and the Fed to take urgent steps of normalization while it is still possible. Now we see the initial steps but they lead to QE no matter what shape it will take. Which means that the strategy has a pro inflationary nature suggesting currency devaluation and keeping nominal rates below inflation. It could be done by ongoing "adjusting" of major inflation indicators that will show the lower levels compares to reality.
Since similar things stand in all major economies, it could make not radical effect on currencies balance, despite that changes in global finances are huge. Nominally rates in the US now are higher and the Fed almost promised to make another hike until the end of the year, which could provide moderate support to US dollar. Besides, EU statistics could change very soon when energy crisis will hit the Europe and ECB policy could change drastically.
This week has passed under the sign of the Fed. It starts acting again and markets now think about the major plan that the Fed and US Treasury are trying to realize. So, the balance of the Fed and ECB policy is changing now. ECB showed no clarity about further steps while the Fed has given a hint on another rate change in 2026. As a result, long term rates stand above their historical level in all G7 countries and nobody surprised with it. Now it is a big concern where this road will lead us. Meantime, next week flash purchasing managers index (PMI) data from the US manufacturing sector landing will give the growling global bond markets something to chew on.
MARKET OVERVIEW
Rising bets on rate hikes around the world have pushed bond yields to multi-year or multi-decade highs in the U.S., Europe and Japan. So far the effect on the FX market has been relatively limited, as yields have largely moved in tandem. The prospect of a new global interest rate-tightening cycle is coming into view as some of the world's top central banks raise rates and signal more may be needed to tame inflation fuelled by the Iran war.
Key rates are already much higher than the rock-bottom levels from the last hiking cycle that began in 2022. But central bankers are under market pressure to show that they are prepared to raise them further to tame inflation expectations and rein in long-term bond yields at multidecade highs. The moves, while formally independent of each other, reflect a shared concern among policymakers that higher oil and gas costs resulting from the Iran war raise the spectre of a new cost-of-living squeeze just a few years after the inflation surge that followed the COVID-19 pandemic.
The dollar jumped against the yen on Friday after two policymakers at the Bank of Japan dissented from a widely expected decision to raise interest rates, raising doubt among traders about the likelihood of further hikes. The BOJ pushed rates to their highest level in 31 years at 1.25%, yet the move did not boost the Japanese currency as traders felt there was a lack of explicitly hawkish guidance. The decision, coming on the heels of the Fed's hawkish message from earlier this week, clears the way for further dollar strength, strategists said.
The dollar index, which tracks the currency against six major peers, was up 1.2% for the week to around a seven-week high after the US Federal Reserve hiked interest rates on Wednesday and signalled more increases could be coming. Traders see a roughly 55% chance of a quarter-point hike at the Fed's next two-day meeting next month, up from 27% a week ago, according to the CME Group's FedWatch tool.
The Fed's unanimous decision to raise rates, coupled with Warsh's comments on Wednesday, were seen as laying the groundwork for further tightening and helped reassure investors about the central bank's commitment to fighting inflation. The Fed's new policy statement and economic projections show a central bank opening the door to tighter monetary policy through next year, with the policy rate rising to the 4.00%-4.25% range by the end of this year and ending 2027 at the same level.
Though the Fed may have delivered on the market's hawkish expectations for now, it might still not raise rates as aggressively as the market expects, making the dollar vulnerable to any disappointment. Markets remain far more hawkish than the Fed. While policymakers project one more rate hike in 2026 and a hold in 2027, investors are pricing in more than one additional increase this year and roughly three more by the end of 2027.
Goldman Sachs expects the US Federal Reserve to raise interest rates again in October after policymakers signaled they may need to tighten further to bring inflation back to target. The brokerage forecast a 25-basis-point increase at the Fed's October meeting. Morgan Stanley and Australia's Macquarie also added a March 2027 rate hike to their existing forecasts for a December increase. The Fed's projections pointed to further tightening, with a 16-2 majority of officials expecting at least one more hike this year and four policymakers forecasting two additional increases.
Goldman said policymakers increasingly favored a quicker return of inflation to the Fed's 2% target, making October the most likely opening for the next move. The analysts inferred from the Fed's messaging that officials could favour consecutive rate increases rather than a more gradual approach.
The shift comes as markets increasingly embrace a "higher-for-longer" interest-rate outlook. Oil prices have climbed above $100 a barrel, adding to concerns that inflation pressures could remain persistent, while recent economic data have pointed to continued resilience in growth. Goldman's revised forecast brings it in line with a growing number of brokerages expecting further tightening from the Fed. Bank of America Global Research has the most hawkish outlook, projecting rate hikes in both October and December.
Economists polled by Reuters also expect at least one more hike by the end of March, reversing a fragile no-change consensus prior to Friday's official data showing firm inflation.
Euro zone wage growth continued to slow last quarter even as inflation picked up, and negotiated wage contracts point to only a mild pickup next year, offering European Central Bank policymakers comfort that price growth remains under control. The annual increase in labour costs slowed to 3.1% in the second quarter from 3.3% three months earlier. Euro zone inflation stood at 3.3% in August and the ECB expects it to rise further in the coming months.
Investors have been ramping up their expectations for ECB rate hikes since the euro zone's central bank increased borrowing costs last week as a widening conflict in the Middle East pushed up the cost of fuel for the bloc. Vujcic, ECB vice-president, said persistently high energy prices would not only push up inflation but could also weaken economic growth by squeezing household incomes and spending.
Money markets price another three or four hikes by the end of next year, with the next one possibly coming as soon as October. That would raise the deposit rate to 3.25% or 3.50%. The ECB has described a rate of more than 2.50% as restrictive, that is curbing economic growth. Two sources told Reuters last week that further tightening was now on the cards. While a hike at the next meeting in October could be in play, a move in December — which would be the ECB's third hike this year — is more likely.
The European Central Bank may need to gradually raise interest rates further to curb inflation before an Iran war-driven rise in fuel costs starts seeping through to wages and other prices, ECB policymaker Martins Kazaks told Reuters. Kazaks argued inflation, which the ECB puts at 3.6% in the last quarter of this year, was still in the "inattention area" for consumers and businesses, but this may change if staples such as fuel and food become even more expensive.
While European Central Bank policymaker Olli Rehn said on Thursday there were no clear signs of second-round inflation effects in the euro zone and backed the use of jointly-issued debt for strengthening the region's defence capabilities.
WEEKLY COMMENTS
So, Someone will be very unhappy. All 12 members of the FOMC voted in favor of tightening policy. This is the first rate hike under the leadership of the new Fed Chairman, Kevin Warsh. The updated dot plot from the Federal Reserve showed that the median forecast of officials anticipates another rate hike by the end of 2026.
16 participants called for one additional rate hike, while 4 participants called for two rate hikes this year.
The Federal Reserve's forecasts for the interest rate have increased to 4.1% in 2026 and 4.1% in 2027, meaning they anticipate another rate hike and a prolonged period of high rates. After that, the rate will only return to pre-current-hike levels by 2029. The forecast for the long-term interest rate has increased to 3.2% and is likely to increase further. However, this means that Trump should not expect "the lowest" interest rates. Only four expect a rate cut in 2027, while eight expect it to be at 4.25%-4.5%, i.e., +50 basis points from the current level.
It seems that the US financial authorities have decided to go through this short path of meaningless decisions, hoping for a miracle. Well, it's a choice – the effort itself is a pleasure. The only thing that Warsh achieved with this move is to demonstrate the Fed's independence from Trump. He saved face, so to speak. But the market frankly doesn't care what face anyone puts on.
The Fed understands: that the fact that they made a completely meaningless decision about a symbolic interest rate hike will not cause investors to rush to buy Treasury bonds. But that's the way the game is played now – the Fed, as it were, doesn't lose the market's trust (because they didn't give in to Trump), and investors... continue to gradually sell US debt (in fact, after the Fed's verdict was announced, the yield on 10-year Treasury bonds began to rise again).
It's hard to say how much time they have left. They might still have time to make one more such pointless decision before the AI bubble bursts. And there's no longer any doubt that it's about to happen, because all the major players in the American AI industry have suddenly, in a united chorus, demonstrated unprecedented concern for the fate of all mankind, stating the need to "slow down" the development of AI. They've taken the lead, as it were.
And when the AI bubble starts to burst, the Fed will finally have a formal reason to make the inevitable, albeit terrible for the dollar, decision – to launch a mega-QE program. The conspiracy theorist deep inside me thinks that this choral performance of a serenade from Silicon Valley is no coincidence. The AI leaders, like the US Treasury, also need those life-saving funds.
Now, pay attention to what's happening:
Warsh is raising interest rates. The interest rates that the Treasury pays on bonds are increasing. Bessent holds Long-end yields low (or trying to). The amount of money the government is paying to creditors is growing. These creditors, mostly institutions, are either parking the increased funds in speculative bubbles or paying it out to their clients. These clients are primarily baby boomer pensioners, whose propensity to consume is approaching to 100%. The amount of money in the economy is growing faster than the economy itself, leading to inflation. Three months later, Warsh looks at the data and raises interest rates again.
And this scenario seems reasonable if we take a look at big divergence among sentiment and consumption. Here's another economic WTF moment. In August, Americans suddenly started spending money. Retail sales rose by 1.2% month-over-month – the highest since March, and up 6% year-over-year. So, based on actual spending, the picture looks like the American consumer is very much alive, and even thriving. And now, the most interesting part.
Consumer sentiment is at historically low levels. This creates a fascinating paradox in the American economy - Sentiment is almost as low as during COVID, while Spending is at record levels. Meanwhile, the actual sales data paints a completely different picture. However, this doesn't necessarily mean that the consumer is healthy. Retail sales are measured in nominal dollars, and inflation itself inflates the numbers.
In July, the United States experienced a net capital outflow of $28 billion, the first in 15 months. Foreign investors did not invest in U.S. government bonds (-$3.6 billion), although they bought other bonds (+$40.5 billion). The inflow into stocks was almost zero (+$3.7 billion), while there was a significant outflow from the U.S. into foreign stocks and bonds (-$68.5 billion). Over the three months, only $59 billion flowed into U.S. government debt, and almost all of that was in May. In June and July, it was practically impossible to attract foreign capital into U.S. government debt - the inflow was less than $3 billion.
Interest payments on the national debt, Social Security, Medicare, healthcare, and veteran benefits are now consuming 98.4% of all federal revenue – almost a record. Since 2022, this figure has increased by 28 percentage points. Meanwhile, interest expenses alone have reached a record 19.7% of the budget's revenue. In other words, virtually every dollar coming into the federal budget is now being used for mandatory expenses and debt servicing. Is there a long-term plan? The question is rhetorical.
Meantime, Currently, there are approximately $7.0 trillion worth of Treasury bills outstanding, with roughly $6.1 trillion of these securities maturing within the next year. Taking into account other obligations, approximately $7.5 trillion of marketable Treasury debt is due to mature in 2026. The US is facing a massive wave of refinancing against a backdrop of rising borrowing costs.
Bank of America strategists argue that the greater risk now is not volatility, but complacency. The yield on 30-year Treasury bonds has reached its highest level since June 2007, and commodity prices are rising sharply, yet "there is no panic anywhere" in the markets, according to a research note from strategists led by Jared Woodard. Turning to the central banks, it's already clear that the global tightening cycle [policy error] will continue one way or another.
CONCLUSION:
It is difficult to say what the shape of the coming Fed's cycle will be, but the one thing we could say definitely - the national debt structure is coming to the breaking point. This makes US Treasury and the Fed to take urgent steps of normalization while it is still possible. Now we see the initial steps but they lead to QE no matter what shape it will take. Which means that the strategy has a pro inflationary nature suggesting currency devaluation and keeping nominal rates below inflation. It could be done by ongoing "adjusting" of major inflation indicators that will show the lower levels compares to reality.
Since similar things stand in all major economies, it could make not radical effect on currencies balance, despite that changes in global finances are huge. Nominally rates in the US now are higher and the Fed almost promised to make another hike until the end of the year, which could provide moderate support to US dollar. Besides, EU statistics could change very soon when energy crisis will hit the Europe and ECB policy could change drastically.
