From "No Rate Cut" to "Inevitable Rate Hike": The Market Has Priced It In, but the Federal Reserve Is Trapped in 3.9 Trillion Debt Dilemma

The New Zealand dollar gave up earlier gains and turned lower against the US dollar during Thursday’s European morning session as market sentiment weakened. Escalating tensions in the Middle East drove oil prices higher, which in turn pushed up US Treasury yields and limited the dollar's decline after it weakened during the Asian session. Another attack by the Houthi rebels in Yemen on a Saudi airport further pushed oil prices higher. With concerns rising over potential further attacks on Saudi oil facilities and potential supply constraints, Brent crude oil prices rose to near $102 per barrel. The rally in oil also lifted US Treasury yields, as markets believed elevated energy prices would force central banks to tighten monetary policy. This offset the slight weakness in the dollar following the release of the US Federal Reserve’s September meeting minutes. The minutes showed that the Fed remains concerned about inflation, but did not alter market expectations that rates would be held steady in October.

Germany’s next-day delivery baseload electricity price fell by 41.2% to 85 euros per megawatt hour.

(1) Banque de France Governor François Villeroy de Galhau stated that the Middle East crisis has triggered geopolitical shocks impacting all economies, including those with relatively strong public finances. (2) As a member of the European Central Bank’s Governing Council, he did not directly mention France’s current difficulties when discussing inflation’s impact on global bond yields. (3) Villeroy de Galhau said, “We observe a strong correlation between oil prices, US long-term interest rates, and European interest rates. This rise in rates affects all countries, regardless of their fiscal health. In fact, some countries with very strong public finances are equally affected, just like those in weaker fiscal positions.” (4) France is currently under close investor scrutiny as it strives to pass a budget and narrow its large fiscal deficit, with related tensions evoking memories of the eurozone debt crisis. (5) Earlier on Thursday, French Finance Minister Bruno Le Maire insisted that there is no difficulty selling French government bonds. (6) Villeroy de Galhau also pointed out that consumer price increases driven by oil and gas price shocks have not significantly spread to other sectors.

Deutsche Bank strategists stated: “A widening bond spread and renewed inflation concerns led to a tough day for risk assets.” The impact was especially apparent in European markets, with the STOXX 600 Index falling by 1.00%, ending a three-day winning streak. France’s CAC 40 Index dropped 1.22%, Italy’s FTSE MIB Index lost 2.51%, and European banking stocks declined by 3.38%, making them the worst-performing sector. “This weakness also extended to the US market, where the S&P 500 Index fell 0.22%, pulling back from the record high reached the previous day. Although the index pared some losses throughout the session, internal pressures remained apparent, with nearly three-quarters of its constituents declining. Industrials and materials retreated by 2.14% and 1.53% respectively, with cyclical sectors especially weak. Technology stocks demonstrated some resilience, limiting the declines in the Nasdaq Index and the ‘Magnificent Seven’ to 0.22% and 0.20% respectively. However, the small-cap Russell 2000 Index dropped by 1.31%, hitting a four-month low.”