London Quick Take – Calm before another storm? Stocks firmer as oil pulls back and bonds steady ahead of key CPI report

London Quick Take – 11 Sep – Calm before another storm? Stocks firmer as oil pulls back and bonds steady ahead of key CPI report

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. Not even a $5.2bn sticking plaster in the form of Treasury buybacks (which underwhelmed) could soothe the pain. The US 10yr jumped 12bps to within a whisker of 5%, an important psychological level. If it breaks here then the next big test is 5.25%, the 06/07 highs. Front end yields moved even more aggressively as the European Central Bank hiked and US wholesale inflation added to the case for the Fed to follow suit, while oil acted like a magnet to pull the curve up. The angst remains elevated with only a slight tick lower across the curve despite oil prices taking a sharp leg lower, with Brent down -4% from its peak. Sentiment hinges both on events in the Middle East and on the US inflation report later – and this all seems to hang on a tenth of a percentage point here or there.

Odds of a Fed rate hike next week have shortened from 60% to 70%, 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. The yield curve is like a coiled spring right now.

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 (based on current FOMC groupthink), not raising rates now would see a further blow out in long-term yields that would force the Treasury to commit to further intervention. As noted yesterday however, the Treasury is in a corner. If Scott ‘The House’ Bessent has all this ‘asymmetric information’ then increasing the buybacks significantly – x10 it to flood the market, would 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 there was strong demand at last night’s 30yr auction, but risks for bond yields remain skewed to the upside despite the size of the recent moves.

It’s been a rough week for stocks and 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 -0.6%, while the Nasdaq 100 fell -1.1%. It was the fourth straight decline for the S&P 500. Both the S&P 500 and Nasdaq are headed for a 1.6% slide for the week, while the Dow is on course for a 2.5% 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 retreated on reports Iran and Gulf states will meet in a push to reopen the Strait of Hormuz. Oman is pushing its allies in the six-nation Gulf Cooperation Council to meet Iranian counterparts on Monday in a bid to crack a deal to at least temporarily reopen the Strait. Brent crude dipped about 4% off its highs to find support at past resistance level of $105. Brent had surged about 6% on Thursday as fighting intensified across the region. Iran-backed Houthis seized a Yemeni Red Sea port, while there were reports of damage to the 5mn bpd east-west pipeline to Yanbu. Saudi Arabia reported it lowest crude output since 1990, underscoring disruption to production. 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 climbed early Friday morning. Gains were modest with the FTSE 100 +0.3% as it holds the 10,600 support for the time being. The DAX was up a similar amount and the CAC added +0.6%. 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 DeepSeek said it managed to reduce the amount of highbandwidth memory needed for its latest model. US futures are trading higher a touch.

US CPI inflation is the big test today and just a small shift in the reading could alter the picture for the Fed. The Fed have kind of got themselves in a position where because of a lack of forward guidance and Warsh’s unwillingness to detail what might trigger a change, the market is filling in the blanks but could be way out. The Fed is in a corner of its own making – Warsh didn’t signal a hike at Jackson Hole but the market is daring him to do it and won’t be satisfied now until it happens. Leaving aside why Fed officials can be swayed by a 0.1ppt 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. Headline inflation is seen at +0.3% MoM, with the annual rate holding steady at +3.4% in August. Core is seen at +0.2% and slowing slightly to +2.4% YoY. FactSet says it could be 3.3%, which would be the third straight month the figure has declined. With markets pricing for a Fed hike next week at 70%, it means that despite a whopping move in front-end rates – the 2yr US yield jumped some +15pbs to a new cycle high 4.598% but clearly could move a lot further if CPI swings the market further towards a hike.

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