Good morning. The dollar is climbing, supported by high oil prices and Treasury yields near their highest levels since 2007. Crude benchmarks are giving back some of their gains as Saudi Arabia ramps up flows through its repaired East-West pipeline, but Brent is still trading around $105 a barrel as talks to end the war with Iran and reopen the Strait of Hormuz show no signs of progress. Benchmark ten-year Treasury yields are holding around 5.21% after briefly touching 5.27% in yesterday’s session.
Widening rate differentials are dominating currency markets, lifting the dollar against all its major counterparts and wrong-footing forecasters. Today’s US job openings and consumer confidence numbers, tomorrow’s inflation data, and Friday’s payrolls report could reinforce this dynamic, strengthening the case for further tightening at the Federal Reserve’s October meeting. Traders are currently putting the odds on a hike at around 70%, up from 56% a week ago.
Idiosyncratic issues are playing a smaller role. The Canadian dollar is weakening as softness in the domestic economy pushes the gap between US and Canadian two-year yields to its widest since early last year. The euro is trading near a three-month low as investors grow more concerned about France’s fiscal trajectory and political gridlock ahead of next year’s presidential election, with the spread between French ten-year yields and German Bunds widening to about 110 basis points — the most since the debt crisis of 2010–12. The pound is exhibiting its usual jitters ahead of the Autumn budget as Chancellor Healey grapples with an unexpected jump in the deficit, higher inflation, and surging borrowing costs. The yen is holding steady as traders brace for another round of intervention. And the Mexican peso is trading near its weakest since April as a narrowing policy gap erodes its carry appeal.
Implied volatility has risen across asset classes yet remains well below historical norms, especially outside bond markets. Several forces are cushioning markets against extreme moves: Investment in artificial intelligence, strong consumer spending and wide government deficits are underpinning corporate earnings. Shifts in central-bank expectations have been broadly synchronised. And high policy uncertainty is curbing any appetite for big directional bets.
But warning lights are beginning to flash. Ten-year Treasury yields have jumped by almost 65 basis points since Kevin Warsh’s Jackson Hole speech in late August, a pace that has often preceded turmoil in the financial system. Although the banking system today looks better capitalised and less exposed to the sort of plumbing issues that have historically produced extreme moves, vulnerabilities may have moved to US equity markets, which look expensive, concentrated in artificial intelligence names, and more reliant on long-duration borrowed money than at any time in recent memory. A correction could widen credit spreads, force companies to cut investment plans, derail growth, and trigger a wholesale repricing in foreign exchange markets.
