Markets began pricing in an uncertainty premium

Markets

Stock markets is where the action was at yesterday. Bumper results from AI bellwether Nvidia (> +8%) particularly lifted the tech boat. The Nasdaq rose almost 1.6%, leaving the S&P 500 (+0.7%) and DJI (+0.2%) behind. The index is less than 3% away from the all-time highs seen in May. Moves in other corners of financial markets stayed fairly limited. Major currencies were little changed. Fixed income faced some selling pressure with US Treasuries underperforming Bunds. US rates added between 2.2 and 3.8 bps with the belly underperforming the wings in technically irrelevant trading. A $44bn 7-yr auction matched the WI with a yield at its highest since December 2024 luring in the expected demand. German yield changes varied between 1.7 and 2.2 bps in a gentle bear flattening move. Euro area money markets drew comfort from the ECB meeting minutes, which concluded that another hike is likely necessary unless the inflation outlook improved significantly. The latter clearly isn’t the case with an economy fairly resilient and energy prices (gas!) well beyond the levels that fed into the July discussions.

The relative muted moves yesterday shouldn’t come as a surprise in the light of Fed chair Warsh’s highly anticipated speech at the Jackson Hole Symposium today. His tight-lipped post-meeting press conferences backfired in July. Being left in the dark, markets began pricing in an uncertainty premium. Some would even describe it as a credibility issue: it doesn’t mean much when Warsh says he’ll bring back price stability but refuses to explain how to get there. Relying on the market to do the job via the current higher long-term rates for example is a tricky balancing act which needs to be validated by the Fed one day, somehow. That strategy is also undermined by the US administration itself, which has been acting, so far unsuccessfully, against the recent uptick in long-term bond yields. Stephen Miran, former chairman of the Council of Economic Advisers and former member of the Federal Reserve Board of Governors, was the latest one to do so. He warned for drawing the wrong conclusions from the rise in yields. It’s not a debt sustainability issue nor a Fed credibility issue. Higher long-term yields reflect increased expectations for future short-term/policy yields, revealing market thinking that “AI, deregulation and better tax policy are turbocharging the American economy.” He draws that conclusion because the other components that make up long-term rates, the term premium and inflation expectations, have been stable more or less. The former is debatable because it is very model-dependent but we’ll give him the latter. Miran jumped Bessent to the rescue and defended his approach to fight “unnecessary volatility at the long end of the yield curve”. Regardless Miran’s charm offensive, it is now up to Warsh to do his part. We expect him to live up to the challenge, he cannot afford a repeat of July. With a growing minority in the FOMC favouring a hike and after this week’s stubborn PCE, Warsh does not even need to explicitly commit to something. A small hint may suffice to support short-term yields, ease pressure at the long end and aid the US dollar.

News and views

Tokyo inflation rose by 0.4% M/M in August with the Y/Y-print increasing from 1.8% to 1.9%, in line with consensus but still the hottest print since December of last year. Electricity and gas subsidies in the Japanese capital suppress inflation will continue to be a drag through October figures. Core inflation measures that exclude fresh food prices or exclude both fresh food and energy rose by 0.2% M/M (1.8% Y/Y) and 0.5% M/M (2% Y/Y) respectively. Services inflation fastened from 1.2% Y/Y to 1.4% Y/Y. That includes an increase in housing inflation (0.5% M/M) with the 1.9% Y/Y price change (up from 1.4%) being the fastest since August 1994. Food inflation was 0.8% M/M and 3.9% Y/Y (from 4%). Overall, today’s Tokyo CPI doesn’t alter the case for near term Bank of Japan policy tightening even if it printed largely in line with consensus. The market implied probability of a 25 bps rate hike at the September 18 BoJ-meeting amounts to 84%. National CPI figures for the month of August will be released that same day.

Venezuela exiting OPEC has been a topic in conversations with US officials, according to people close to the matter. Bloomberg reports that no final decision has been made. The move comes after the US triggered regime change earlier this year with Washington also thinking about taking large oil stakes in the country’s oil fields. A Venezuelan exit would have less impact from a production point of view than the UAE’s decision to do so a couple of months ago, but would further pressure the shelf date of the Saudi-led cartel.

Download The Full Sunrise Market Commentary