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News flow in financial markets has again been led by the impact of geopolitics, with oil and gas prices pushing higher as a result of further retaliatory attacks between the US and Iran, along with comments from President Trump suggesting the conflict was set to endure until the US mid-term elections in November. Consequently, the rise in commodity prices has increased expectations that inflationary pressures will persist, leaving central banks with limited options other than increasing interest rates. The impact on financial markets was clear, with equities struggling, and bond yields moving higher. On Wednesday, Brent Crude climbed above $100/barrel for the first time since late July and traded as high as $109/barrel yesterday. Brent peaked at $126/barrel in late April and fell as low as $70 in July. US retail diesel prices rose to $5.85/gallon – a record high, eclipsing the previous record in 2022. European and UK gas prices continued to climb, with prices up 173% and 183% respectively year to date. By contrast, oil is ‘only’ up 63%. Concerns over the limited filling of storage ahead of the ‘heating season’ (has ‘winter’ rebranded ?!) were also on the rise. As of Sunday, European storage levels were 67% full, well below the five-year average for early September of 83%. At least most European countries have gas storage infrastructure – Germany has the capacity for around 4 months of gas demand when storage is full; by contrast, the UK capacity is only for 6 days of demand.
The European Central Bank said it is bracing for “longer lasting inflation” as it increased interest rates by 25 basis points to 2.5% in the second rate hike of the year. ECB President Christine Lagarde said the bank expected inflation to only return the 2% target “by the end of 2027”, noting the price shock resulting from higher commodity prices would be more persistent. Lagarde said yesterday’s decision was a “no brainer” given “we believe inflation will be longer lasting than we anticipated”. Markets are pricing a further rate hike from the ECB before the end of the year.
Bank of England Governor Andrew Bailey told the House of Commons Treasury Select Committee that the war in Iran and the effects of extreme weather now threaten to ignite a new burst of inflation. Bailey commented that the near closure of the Strait of Hormuz and pressures on refining capacity could lead to even higher energy prices. Bailey said, “we have higher energy prices; they could be higher still; the risks, I am afraid, are on the upside”. The drought in the UK and global El Nino triggered weather conditions could also force revisions to the inflation forecast, with Bailey noting that “this is another area where the risks to inflation are on the upside”.
By Numbers
US non-farm payrolls stronger than expected at +162k in August vs consensus of +55k. There were revisions of +55k to the two prior months, erasing the negative print first reported for July.
China’s exports rose by 25% year-on-year in August, leaving the country on track for another record annual trade surplus. The surplus for the first 8 months of the year totalled $805.51 billon, outpacing the equivalent figure for 2025 of $785.34 billion. Imports were up 28%, and imports from South Korea were up 108% as demand for chips for the AI equipment boom continued to surge.
President Trump told a campaign rally that every US adult would be a $5,000 “dividend” if the Republican party ‘wins’ the November midterm elections. Speaking at the Republican Party’s mini-convention, Trump gave no details of the plan but told voters to “pretend that I am on the ballot just one more time”. There were immediate questions over the cost and legality of the offer. Such a payout could cost $1.3 trillion and eclipse the covid-era stimulus cheques.
Market movers
Today we have a proper ‘market moving’ data point – the release of US inflation data for August, the outcome of which will have a huge influence on the outcome of the Federal Reserve (Fed) rate setting meeting next week, and of course consequences for currencies, bond markets and wider market sentiment.
Expectations for a US rate hike were boosted by strong jobs data last week, so this data point will likely firm up views for what happens next week. The Fed is now in a ‘blackout period’ meaning Fed members will not give further guidance or comment ahead of the meeting. Historically the narrative was that the Fed would ‘nudge’ market expectations towards at least 70% probability before a policy move, such that policy ‘shocks’ were limited. In the new Kevin Warsh era, they appear comfortable to play their cards close to their chest.
Over the course of this week, expectations for a Fed hike next week have climbed to the 70% level. Given how much weight Warsh has put on the inflation data, and his frustrations with inflation persistently above target, this afternoon’s CPI print feels important for firming up those expectations. Bear in mind CPI hasn’t been below the Fed’s target since 2021, and the data for August to be published this afternoon is expected to show US inflation at 3.5% year on year. A higher inflation print will likely boost expectations the Fed will have no choice but to hike rates next week. The focus either way will be very much on this afternoon’s data point followed by the policy moves (or not) and Kevin Warsh’s press conference next week.
The investment lens
This is a busy period for the central banks and we’re in the midst of more ‘higher for longer’ type conversations, with commodity and food price pressures making headlines, and with inflationary pressures building, concerns that central banks can ‘watch and wait’ no longer. The ECB has now hiked rates twice this year, and may still need to go further, albeit balancing inflation risks to the upside with potential downside risks to growth. The Bank of England (BoE) had appeared in no hurry to raise rates, though their inflation forecasts are now some way behind the market consensus, with further risks to the upside should energy prices continue on their current trajectory. For now, the BoE is not expected to hike until November. Given Andrew Bailey’s more hawkish tone this week, they may not wait that long, though the Bank faces the same inflation vs growth balancing act as seen in the eurozone. Andrew Bailey has the opportunity to give further guidance following the MPC meeting next Thursday. Next week will see not only the Fed meeting but also the Bank of Japan, where a 25 basis point rate hike is fully priced in by markets. But there has been some chatter about a larger hike, to keep on top of inflationary pressures but also to support the Japanese Yen, which continues to be particularly weak. US Treasury / Bank of Japan intervention has for now halted the slide in the currency but if the Bank of Japan is able to normalise rates towards the levels seen in other developed markets, the pressure should ease further. Whatever happens next week, the intensity around central bank policies is set to persist given that inflationary concerns are on the rise once again. As has been the case for some time, a resolution to the issues in the Middle East still appears to be the dividing line between a benign outcome for inflation and rates trajectories and a more sobering outlook.
