RECAPPING LAST WEEK
Global equity markets were under pressure last week with rising energy prices, escalating U.S.–
Iran hostilities, and another leg higher in Treasury yields. U.S. equities gave back much of the gains
from the prior week, with the S&P 500, Nasdaq 100, and Russell 2000 all slipping a little Tuesday
through Thursday before regaining some ground on Friday. The selloff was relatively orderly, with
the market continuing to focus on whether the increase in energy prices represents a temporary
geopolitical shock or the beginning of a more persistent inflation problem. The biggest pressure
came from the energy market as the conflict between the U.S. and Iran intensified, with the U.S.
destroying Iranian oil tankers off their main export hub of Kharg Island and continued efforts by
Iran to threaten traffic through the Strait of Hormuz. Iranian–backed Houthi rebels also took
control of the strategic Red Sea port of Mokha, which has threatened Saudi Arabia’s ability to
export oil through the Bab–al–Mandeb Strait. Brent crude surpassed $110 per barrel on Thursday
and WTI $104, before pulling back in Friday’s trading. U.S. diesel prices rose to $6 per gallon as
refiners continued to benefit from margins that have now surpassed the levels seen in the first
month of the conflict. The rise in energy prices was accompanied by another sharp move higher in
Treasury yields. The 10–year Treasury yield approached 5%, while the 30–year breached 5.40%,
the latter at levels last seen in 2007. The Treasury’s announcement of a $6 billion long–term
buyback failed to provide relief, with yields moving higher following the announcement. Technology
and Energy saw the biggest gains among the S&P 500 sectors, while Consumer Discretionary and
Healthcare were the laggards. The August CPI report came in largely in line with market
expectations, showing that the headline number remained at 3.4% year–over–year while the core
(which excludes food and energy) down ticked a tenth to a 2.4% annualized rate. The momentary
knee–jerk response to the figures that significantly increased market expectations of a hike in the
Fed Funds target rate at next week’s meeting was a selloff in Treasuries, equities, precious metals,
and crypto, but within a minute, all reversed course in one of those “buy the rumor, sell the fact”
type moves that is only noticed in the rear–view mirror. Friday’s reversal of the early week moves
was also reflected in a compression of implied volatility in stock option pricing as the VIX retreated
to its complacent levels in the mid–teens after a surge into one–month highs on Thursday.
THE WEEK AHEAD
Investors will be focused on the FOMC’s 2–day meeting, which concludes on Wednesday with the
Fed Funds futures market now pricing in an 85% probability of a 25–basis point hike in the Fed
Funds target rate. With $100 crude oil, longer–dated Treasuries at multi–year highs and inflation
remaining above the Fed’s stated 2% target rate, markets are now concerned that the Fed’s job
might not be complete with a one–and–done hike but rather may be forced into a tightening cycle.
In fact, Fed Fund futures reflect only a 25% probability that rates are only 25 bps higher than the
current target by year–end. Other central banks will also have rate decisions to make, with the
Bank of England expected to hold rates steady on Thursday while the Bank of Japan is widely
expected to hike rates by 25 bps on Friday, perhaps confirming the “asymmetric information” U.S.
Treasury Secretary Bessent alluded to after undertaking the coordinated intervention to support
the Yen. All things considered, U.S. equities, still buoyed by robust earnings, have shown
remarkable resilience, acting like an inflatable ball pressed beneath the water’s surface in
response to adverse macro influences, while shooting higher whenever the pressure is removed.
(Schwab)
