Good morning, and happy Federal Reserve Day to all who observe. With geopolitical risks and an ongoing rout in artificial intelligence stocks combining to suppress risk appetite, currency markets are struggling to gain momentum ahead of this afternoon’s Federal Reserve rate decision. The euro, pound, and yen are virtually unchanged, and the trade-weighted dollar is flat.
Oil prices are holding firm after jumping more than 5% last night following what American officials called a “surprise”* Iranian attack on a US airbase. US and Saudi forces separately struck Iran-backed militants in Iraq after a series of drone attacks against Saudi energy facilities. Flows through the Bab el-Mandeb are showing signs of recovery, but the Strait of Hormuz remains effectively closed—and with Iranian officials reportedly rebuffing Omani proposals for joint control of the waterway, an immediate breakthrough appears unlikely. Prices nonetheless remain below last week’s highs, and the Canadian dollar—which is a petro-currency in the sense that Taylor Swift is a country music singer**—is up less than 5 basis points.
Convulsions in global technology indices are continuing. South Korea’s Kospi is down almost 40% from last month’s high, with selling accelerating last night after SK Hynix reported a disappointing 557% jump in operating profit*** and the Nasdaq is nearing correction territory as investors act on concerns about stretched valuations. Microsoft and Meta report after the bell this afternoon, followed by Apple, Amazon and Samsung tomorrow.
Futures-implied odds on a rate hike from the Fed are holding near the one-in-three mark. Surprises are possible, but we expect a “hawkish hold”, with at least two dissents in favour of tightening now, and a statement that clearly warns inflation risks are outweighing those to the labour market. With tightening expectations for the autumn remaining elevated, front-end rate differentials—which have driven the bulk of the dollar’s moves in recent years****—should remain supportive of the greenback in the near term.
However, we think a dovish repricing is coming over a longer time horizon. The cost pressures that have buffeted the US economy in recent months—energy, tariffs, and AI-driven supply-chain strain—should lose steam over time. Core services inflation remains elevated, but there is little evidence of spillovers into the broader price basket, and both market- and consumer-based measures of inflation expectations remain well anchored. The foundations of the current expansion look narrower than the headline data suggest: tax cuts are increasingly being offset by rising energy costs, a short period of tariff relief is about to end as new levies take effect, and business investment and consumer spending are heavily dependent on continued gains in technology valuations that have begun to falter. Labour markets also appear more fragile than the unemployment rate implies, with net payrolls growth outside healthcare and education running close to zero and wage gains remaining weak. The US surprise index—a measure of realised economic performance relative to forecasts—could roll over in the coming months.
Against this backdrop, we believe the longer-term path of least resistance is for the Fed to stay on the sidelines, yields to edge lower, and the dollar to retreat modestly from current levels.
*It’s a little unclear as to why this was considered a surprise, given that the US and Iran are at war with one another.
**It’s only a petrocurrency when it wants to complain about things.
***That this is considered disappointing is a reflection of overwrought expectations—something familiar to those labouring under sales targets or marital chore requirements.
****Note rate differentials are themselves a reflection of relative gaps between central bank policy expectations, which are in turn shaped by inflation trends, labour market and broader economic data, shifts in investor risk sentiment, and safe-haven demand, among other factors.