Yields Continue their Move Higher

MACRO FRAME

US activity remains resilient enough to prevent a disinflationary narrative, while fiscal stress has become increasingly evident in euro-area dynamics.

STOCK INDEX FUTURES

Equity index futures moved lower overnight as oil prices and Treasury yields rose, reflecting what has been the theme of the week. There are currently several news reports of a major attack by Houthi rebels in Saudi Arabia, who target airports in Abha and the city of Riyadh over the past two days. So far strong AI-related revenue and earnings expectations have outweighed pressure from higher yields, though Q3 earnings set up a major test for the market. Analysts expect Q3 S&P 500 earnings to rise 30.6% year over year, led by energy and technology. However, that concentration leaves the market increasingly dependent on a relatively small group delivering strong results and guidance. The key question entering earnings season is whether profits can continue to offset the higher cost of capital, and whether that resilience broadens beyond the current leaders. The equal-weight S&P 500 stands more than 5% below its record and the Russell 2000 more than 8% below its peak. Despite a near 23% rise in the S&P since its March 30 low, 199 members have declined. Large technology companies have contributed enough index gains to offset that weakness, making headline performance an incomplete measure of broader corporate conditions.

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 0.12% to 102.36, remaining near April 2025 highs. September’s Fed minutes reinforced inflation concerns and the possibility of further tightening. Markets continue to assign an 80% probability to an October hold, but a December hike remains fully priced. Elevated bond yields and renewed oil-price pressure remain supportive of the dollar. Meanwhile, its role as a defensive currency amid the absence of an attractive large-currency alternative is also dollar positive. The euro, the traditional primary counterpart to the greenback, is weakened by France’s fiscal and political risks; today’s minutes are the key catalyst for dollar direction.

Watch point: While current fiscal, macro, and geopolitical factors favor the dollar, it is beginning to enter overbought territory and could be susceptible to a modest correction.

EURO: The euro fell 0.17% to $1.1178 as yields and oil moved higher in Europe. The French-German 10-year spread rose 6 bps to around 142 bps overnight  as investors increased risk premium related to French Fiscal stress. While the increase in French yields has been dramatic, it does not reflect an emergency. The speed of the move likely resulted in leveraged investors being forced to unwind long OAT positions, which could have amplified the fundamental repricing. A move back to the 150 bps area could be difficult to reach. However, that should not be confused with restored fiscal credibility. French politics and expectations surrounding future fiscal policy will play an outsized role in euro price direction in the near-term. There is a consensus to rein in spending, though there is likely little that can be resolved ahead of the French presidential election and ensuing legislative elections. The 20-day rolling correlation between the French/German-10/yr. spread and euro is at -0.95, reflecting almost a perfect negative correlation and its highest correlation this year. Around every 10 bps of widening in the French-Germany 10-year spread is associated with a 0.4% fall in euro. A Reuters poll showed that 90%  of economists surveyed expect the ECB to raise rates once more in December, after previously expecting the bank to be done with its tightening cycle. The ECB’s September meeting minutes showed that policymakers considered it vital not to signal any further policy move and keep all options on the table, though noted that inflation could turn out higher than expected.

Watch point: French sovereign stress will continue to be a dominant factor in price direction, however, the $1.10 level acts as a strong resistance level.

BRITISH POUND: Sterling fell 0.11% to $1.3197, though remains near a 16-month high against the euro. Bank of England Governor Andrew Bailey and policymaker Lombardelli are set to deliver speeches this morning, which could influence expectations on the bank’s next move. Both are viewed as centrists on the committee; while hawkish remarks would be favorable to the pound, money markets are already quite aggressive in their pricing. Money markets are priced for 100 bps of tightening over the next twelve months and place an 85% chance of a hike next month. Globally, the focus is on the dollar and euro. The latest French episode favors sterling largely through relative euro weakness, not through a distinctly improved UK fundamental backdrop.

JAPANESE YEN: The yen slipped 0.12% to 158.24 yen per dollar. Data released overnight showed Japan’s current account surplus rose to $25.7b in August, above expectations. Still, the currency remains under pressure from US rate differentials and a market that is unconvinced the central bank will raise rates in a timely manner. Policymaker Sato said in an interview that she supports the idea of raising interest rates in several stages, but the comments did little to move policy expectations. Mainly, the lack of conviction stems from the bank’s recent communications following its split decision to raise rates and the following summary of opinions, which provided little clarity on the timing of the next potential rate hike. However, the minutes did point to a board more favorable to raising rates once more. The greatest near-term upside risk for the currency remains market intervention. Markets are pricing roughly a 10% chance of a hike in October and see 20 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 fell 0.24% to $0.6942. The Australian 10-year yield is trading near a 15-year high of 5.43%, though US yields have risen at a fast pace, causing the AUS-US premium to fall to just 8 bps from around 40 bps in mid-September. That dynamic has recently pressured the currency and could continue to do so if the RBA holds rates for the foreseeable future, while the Fed raises rates. This will leave RBA policy expectations to play a large role in price direction. Monthly inflation data came in just under forecasts and led markets to further reduce odds of a near-term rate hike. 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 RBA’s decision to raise rates by 25 bps to 4.60% last week. 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 higher overnight alongside a rise in oil prices. Fed Governor Waller this morning said that additional rate hikes will likely be needed to lower inflation to target, but noted there was “flexibility” about the pace of increases. He is the third Fed official this week to indicate that the bank prefers a pause in policy in October, as policymakers look to further evidence to assess when an additional tightening would be necessary. His comments were reflective of the tone of September’s  meeting minutes. Policymakers discussed whether persistent inflation, driven by energy, tariffs, business pass-through and the AI investment boom, could broaden and become entrenched. They generally agreed that the labor market was near maximum employment and growth remained solid, reducing the need to protect against downside employment risks. The main policy question was therefore not September’s hike, which everyone supported, but how much further to tighten: most expected another hike by year-end, although they differed over whether it was needed under their baseline outlook or primarily as insurance against upside inflation risks. Money markets assign an 80% chance of hold from the Fed rate come October, though remain fully priced for a hike by year-end, with further tightening expected in 2027. That pricing will continue to support yields despite recent Fed commentary that favored a hold come October following August’s softer PCE and labor-market data.

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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