Good morning. A palpable sense of caution is pervading global markets after Alphabet reported stronger-than-expected second-quarter earnings but raised its capital expenditure forecast, reigniting concerns about the sustainability of the AI investment cycle. Google’s parent delivered its strongest-ever quarter of growth in cloud computing, but said it would spend as much as $205bn this year building out data centres after having already committed $44.9bn in the second quarter alone. Separately, Tesla reported negative free cash flow of $1.1 billion in the second quarter, while its net income fell 5%. Amid a dramatic pivot away from the capital-light operating model that has long defined the US technology sector, investors are growing more anxious about earnings growth, valuations, and returns—and nervous jitters are beginning to show across a number of asset classes, including equities, fixed income, and currency markets.
Energy prices are climbing once again as the conflict in the Middle East widens on multiple fronts. Iran’s Revolutionary Guards said an oil tanker was hit by an explosion in the Strait of Hormuz and that two others had turned back. American forces carried out a twelfth consecutive night of strikes after President Trump threatened to bomb a bridge or power plant each time Tehran attacks a vessel transiting the strait. Yemen’s Houthi rebels claimed strikes on two Saudi oil tankers last night, opening a new theatre in the supply disruption*. Brent is trading just below $100 a barrel, up 34% this month, with West Texas Intermediate approaching $90 and the US national average gasoline price—which plays a huge role in driving inflation expectations and the political economy—back above $4 a gallon.
The euro is holding its earlier losses even after the European Central Bank left rates unchanged and signalled an openness to further tightening. In this morning’s widely-expected decision, policymakers said “uncertainty remains and the full inflationary impact of the energy shock has yet to play out,” but stopped short of committing to further moves. With two hikes already priced in by early next year, policymakers are finding it difficult to out-hawk markets, and the narrowing in short-term interest rate spreads that has supported the currency for much of the past year is beginning to lose traction. The euro looks undervalued at these levels, but it may take a breakthrough in the Middle East or a material drop in American equity markets to generate the momentum needed for a near-term push back through the 1.15 threshold against the dollar.
More generally, yields are ratcheting higher as investors brace for further monetary tightening while absorbing a deluge of Treasury and AI-related issuance. Short-term US rates have climbed, with traders now placing near-35% odds on a rate rise at Wednesday’s Federal Reserve meeting, a move fully priced in by September, and another expected by March 2027. This is driving curves up in a sympathetic fashion across most major economies. Yet long-term rates are also pushing upward, with term premia—the compensation investors demand for holding long-duration assets—edging higher as a flood of supply from governments and the technology sector competes for the same pool of buyers.
Nowhere is the pressure more acute than in Japan. Short-term interest rate differentials are playing a major role: although the Bank of Japan has raised its policy rate to a 31-year high of 1%, that remains low relative to its major peers and is, in real terms, deeply negative. Soaring energy prices are compounding the problem—Japan imports roughly 90% of its energy, with 95% originating in the Middle East. But the term premium embedded in Japanese government bond yields has also climbed sharply, reflecting a growing conviction that the country’s fiscal and monetary settings are too loose and the economy too fragile to withstand a tightening in either. The yen is trading near its weakest level in four decades, and even an acceleration in the Bank of Japan’s normalisation may not be enough to reverse the slide. With investors finding a growing number of alternatives to government debt, capital is flowing out of Japan rather than in—and until that dynamic shifts, the currency will remain under pressure.
Markets could run into turbulence over the next week. The Federal Reserve will deliver what promises to be a fraught decision, Microsoft, Meta, and Amazon will report their latest earnings, and the Trump administration—with its economic approval ratings now deeply underwater—could take action to bring the Iran conflict to a close**. Against this two-sided risk backdrop, volatility expectations embedded in currency markets look too low, making the typical summer lull in corporate hedging behaviour unusually dangerous. Fasten your seatbelts, stow your tray tables, and put a trading plan in place.
*It’s important to note that although their threats can certainly slow traffic, differences in geography and targeting capabilities mean the Houthis are unlikely to achieve a full closure of the Bab al-Mandeb.
**One way or another.