Good morning, and happy Saturday.

Central bankers are still talking about inflation. Markets are starting to worry about growth. The war with Iran is exacerbating global inflation pressures and pushing up borrowing costs, straining economies burdened with heavy debt loads and wide budget deficits, while a reversal in technology sector valuations is dimming prospects for corporate investment and consumer spending growth.

Oil prices are holding near their highest levels since mid-April as markets hunker down ahead of possible strikes on Iran. Brent futures ended the week near $116 a barrel after a series of media reports and evacuation notices, along with the repositioning of military hardware, pointed to another round of attacks soon after America’s midterm elections on November 3rd. Iran, for its part, has threatened to retaliate against American military and civilian targets in Gulf countries. Even without fresh hostilities, volumes through the Strait of Hormuz remain roughly 20% below pre-war levels, and surging shipping costs are lifting prices across the energy complex, particularly for refined products.

The artificial intelligence boom is undergoing a hard reset. The Nasdaq is down 2.9% in the last two days, semiconductor sub-indices are coming under sustained selling pressure, and credit spreads on hyperscaler bond issues are widening sharply as investors grow less confident an unprecedented – and increasingly debt-fuelled – capital spending cycle will translate into revenue growth.

The spread between French and German government bonds is at its widest since 2011 as investors brace for another round of violent protests today and tomorrow, deepening France’s political dysfunction and complicating efforts to put public finances on a sustainable path. A reprieve from the Moody’s rating agency, which said yesterday it was maintaining the country’s bond rating and assuming that a “deficit-reducing budget for 2027 will be adopted” with financing costs and social tensions abating over the next few months, is unlikely to turn the tide, given that it kept its negative outlook, mirroring assessments from other agencies.

Rates markets are reacting unevenly. A full hike has been stripped from the Federal Reserve’s expected path and Treasury yields are down sharply from their highs, and volatility expectations are climbing across asset classes – but the dollar’s decline is being cushioned by safe-haven demand, helping limit the damage in most major currency pairs.

A pivotal week beckons:

John Healey hopes to lull markets to sleep when he delivers his first autumn budget as chancellor of the exchequer on Wednesday, and a carefully calibrated communications strategy in the run-up to the release suggests that he could succeed. Investors expect him to maintain fiscal discipline, keeping “headroom”, the buffer against the government’s main borrowing rule, above £15bn even as he unveils a series of small-scale changes to tax and spending plans, from deregulation and relief for small businesses to an increase in the bank surcharge, alongside a cost-of-living package that helps households cope with rising energy costs. Borrowing costs remain extraordinarily high, but the “moron risk premium” that has been embedded in British asset prices since Liz Truss’s brief premiership has faded, affording him some breathing space.

The pound’s near-term outlook remains favourable, though the story could change significantly by early 2027. Britain’s economy has grown faster than any other in the G7 this year, and the latest numbers on inflation and wages have bolstered expectations for a total of four rate hikes from the Bank of England by next summer, widening interest differentials in sterling’s favour. The currency could follow a buy-the-rumour, sell-the-news pattern around the budget, but once that is out of the way and the event risk has cleared, investors could unwind their remaining short positions and add to carry trades.

Swap markets are putting 80% odds on a hike when the Bank of Canada meets on Wednesday, and are pricing in three more over the coming year. Traders expect policymakers, still scarred by the “transitory” misjudgement of 2021, to launch a pre-emptive strike against rising inflation expectations after surveys for the third quarter showed consumers and businesses bracing for faster price increases. Governor Tiff Macklem has done little to dissuade them. Speaking in Bangkok last weekend, he said he expects the bank’s new inflation outlook to come in “quite a bit higher” than its July forecast, suggesting that tighter policy may be needed to nudge it down.

A “risk-management” hike could add to the dangers facing the economy. Recent data show no sign of demand-driven inflation, nor of energy prices spreading into other goods and services, and the bank’s preferred core measures remain below target. Overall economic sentiment is showing signs of improvement, yet consumers remain cautious and businesses are deferring hiring and investment, which leaves ample slack in the economy. Nor is there much evidence that policy is too loose at current rates – particularly in the housing market. A hike would, by design, add to the forces already weighing on growth.

This argues against a binary reading of the decision. Taking out insurance now should lower inflation expectations and weigh on the growth outlook, reducing the need for further tightening in the year ahead, whereas a hold could have the opposite effect. And as markets pare back their bets on future hikes, rate differentials could turn into a headwind for the Canadian dollar, even as broader fundamentals favour a slow grind higher against the greenback.

The Federal Reserve, by contrast, looks set to deliver a hawkish hold later in the day. The “dot plot” of rate projections published in September showed most officials favouring only one more hike in 2026, and recent communications have pushed back against expectations for tightening, with officials such as John Williams, Philip Jefferson, and Christopher Waller arguing that there is no urgency to raise rates. In keeping with recent practice, the statement is likely to be brief and shed little light on how officials see conditions evolving, while chair Kevin Warsh should remain circumspect. The hawkishness will come from the vote instead, where at least three dissents look probable, with Beth Hammack, Neel Kashkari and Lorie Logan backing an immediate hike and others possibly joining them. September’s personal income and spending data, along with third quarter gross domestic product numbers, due the following morning, should keep expectations aloft, showing inflation running above target and an economy in decent shape, buoyed by resilient consumer spending and the build-out of artificial-intelligence infrastructure.

The European Central Bank is almost universally expected to leave interest rates on hold when it meets on Thursday. As in other big economies, pass-through from energy costs to underlying inflation remains muted, while rising bond yields are tightening financial conditions on the bank’s behalf, limiting the need for an aggressive course of rate hikes. Yet energy prices now sit between the “adverse” and “severe” scenarios in the bank’s own projections, suggesting that officials could use the meeting to lay the groundwork for a hike in December. This is unlikely to move the euro much, with markets already putting the odds on a December move at around 80%.

Bigger uncertainties may emerge in the post-decision press conference, where Lagarde’s response to questions about the continuing sell-off in French government bonds could set off fireworks. Although no one expects anything as dramatic as Mario Draghi’s pledge to do “whatever it takes”, she could subtly telegraph a shift in the bank’s reaction function, indicating that an unwanted tightening in financial conditions is weighing on the outlook for growth and inflation, and so reducing the need for further hikes; or, in a more extreme case, hinting at a more interventionist approach. Either message could open up downside in the common currency, but we see this as somewhat less likely, and think a more reticent Lagarde might force speculators, who are currently holding the biggest euro short since 2016, to unwind some positioning.

The Bank of Japan’s meeting should be a non-event, with policymakers expected to leave rates on hold and to maintain guidance pointing to a quarterly pace of hikes over the year ahead. Traders see the next move coming in December or January and have three in total priced in by next autumn, leaving rate differentials tilted against the yen.

Bottom line: A series of event risks could generate whipsaw price action across currency markets in the days ahead. A hawkish hold from the Fed, followed by solid numbers on spending and output, could help the greenback find a floor, and safe-haven flows should help offset an unwind in foreign investment demand until after the midterms. Sterling looks best placed among the majors, with a well-received budget potentially clearing the way for investors to rebuild carry trades on the back of the Bank of England’s expected hikes. The Canadian dollar should continue its climb, but faces challenges in the near term as the risks associated with an “insurance hike” temper expectations for further tightening. The euro is the most exposed to turbulence, with the sell-off in French bonds, narrowing rate differentials, and the risk of a more dovish tone from Madame Lagarde together leaving it open to further losses – while also implying that positioning has become stretched and prone to sharp reversals.

Growth risks could, however, soon supplant central-bank rhetoric as the main driver of interest-rate differentials. It is becoming increasingly clear that rising energy prices and tighter financial conditions will weigh on global growth, and we expect investors to pull back on tightening expectations across the advanced economies over time. The pace and sequencing of that adjustment is likely to unleash currency volatility.