Author: Igor Kuchma

The weekend was far from quiet, with fresh protests across Europe, but tensions in the Middle East didn’t escalate as feared, sending oil prices lower at the start of the week. 

But the pullback didn’t last long — Brent was back at $116 a barrel on Tuesday, as the risk of another US operation against Iran after the midterm elections remains. On top of that, the US Strategic Petroleum Reserve has fallen to 282.6 million barrels, meaning that even if the conflict ends tomorrow, demand could still outstrip supply for some time. 

As for Iranian official Mohsen Rezaei’s claim that talks between Iran, Saudi Arabia, Turkey and Pakistan in Tehran went well, we’ve heard similar positive signals before, but they haven’t brought peace. Why should this time be any different? 

Now, although uncertainty remains, markets still expect the Fed and the ECB to hold rates steady this week. But Warsh and Lagarde may warn that higher energy prices could fuel inflation while slowing growth, keeping rate hikes on the table further down the line.

The same goes for the Bank of Japan, which is also expected to hold rates on Thursday but could still offer clues about a possible December hike.

Another big focus this week will be corporate earnings, as doubts about the AI rally continue to grow amid soaring spending on data centers and infrastructure, while productivity gains remain hard to spot across much of corporate America. It’s also worrying that Big Tech keeps growing while the rest of the S&P 500 struggles to keep up. On top of that, there are concerns that some of the $3.5 trillion being poured into AI infrastructure could lose value before 2030.

Hopefully, results from Meta, Tesla, Netflix and IBM this week will show whether all that spending is finally paying off. And if not, another sell-off could boost safe-haven assets like Treasuries. 

US inflation rose at an annual rate of 3.7% in September and 0.65% month over month. Producer inflation, which measures changes in the prices of goods used as inputs in the production process, reached 6.3% year over year and 1.3% month over month. 

The main driver was energy prices, up 9.3% monthly and 35.3% annually, accounting for over half of the monthly increase in consumer prices. 

Core inflation, excluding food and energy, came in at 2.6% year over year and 0.3% month over month, with persistent services inflation at 3.2% annually and goods prices facing additional pressure from Trump’s tariffs and rising electronics costs amid the AI boom.

No wonder the probability of a December rate hike rose to 75%. One would expect Treasury yields to rise and the S&P 500 index to fall, but while stocks did pull back, bond prices went up instead. Why? 

It was a risk-off move rather than expectations of a more dovish monetary policy path in 2027, as a sell-off in semiconductor stocks, concerns over China’s CXMT advancing in high-density DRAM development, and fresh worries about CoreWeave prompted investors to seek safe-haven assets. 

What is next?

Meta’s quarterly results could set the tone: strong numbers could fuel a rebound if investors see AI spending translating into real returns, with stronger orders, solid margins and sustainable cash flow; otherwise, the tech sell-off could deepen, driving investors toward Treasuries and pushing yields lower. 

Beyond that, inflation is still running hot, energy prices remain high, and the labor market is holding up, giving the Fed little reason to turn dovish anytime soon. If anything, yields may be more likely to move higher again, especially if tensions in the Middle East escalate and push energy prices up further.

Energy prices are weighing on American voters, with 74% very concerned about gas and energy costs, up from 60% in July and 43% in January, according to a Pew Research Center survey conducted September 28–October 4, 2026. 

Heading into the midterms, numbers like these obviously put Republicans at a disadvantage, hence another TACO over the weekend, bringing Russian diesel back to global markets, including the U.S. 

Under the deal, Russia will supply 300,000 tonnes of diesel immediately, 500,000 tonnes in November, and 1 million tonnes later, with another 3 million tonnes potentially to follow, after the U.S. Treasury temporarily lifted sanctions on Russian fuel imports until April 7, 2027. 

Still, Brent crude hit $107 a barrel on Monday, while the IMF raised its average oil price forecasts for 2026 and 2027. Why doesn’t the market care? 

First, agreeing to supply fuel is one thing; actually delivering it is another. Russian refineries are still struggling with Ukrainian drone strikes, raising questions about how much diesel Russia can realistically supply, despite Moscow’s claims of a surplus. 

Second, as The Wall Street Journal noted, the volumes are too small to offset the global shortfall caused by disruptions to Middle Eastern fuel exports amid the war in Iran and damage to Russian refining capacity, while U.S. refineries are already running close to full capacity.

Meanwhile, Iran has warned regional countries that another war could trigger ground incursions into neighboring states, raising the risk of further supply disruptions in the Middle East.

Resolving the energy crisis requires peace in the Middle East, but the signs point in the opposite direction. As geopolitical tensions keep inflation risks elevated and pressure on global bond markets, US inflation data will take center stage on this week’s economic calendar.

We’re still not getting much good news on the geopolitical front, which might be good for USOIL, but not so much for the rest. 

Starting with Eastern Europe, Russia’s Defense Ministry said it would step up strikes on military targets in Kyiv and other parts of Ukraine, in response to Zelenskyy saying Ukraine would intensify attacks on Russian refineries.

And even without that, Russia’s new budget suggests that war, rather than peace, remains the baseline, with military spending rising to 17.1 trillion rubles, or around 7% of GDP, in 2027, up from an average of 2.8% in 2017–2021. 

In the Middle East, the U.S. withdrew B-1 bombers from Fairford amid warnings of a possible Iranian attack, not clear signs of a deal. Hence, government bond yields briefly hit their highest levels since 2002 before pulling back.

If both wars ended next week, what would happen to global bond markets? 

Sure, the immediate reaction would be positive as one of the main inflation risks would fall, giving central banks less reason to keep monetary policy so tight.

Beyond that, though, there’s a bigger problem: rising bond yields aren’t just about the energy crisis, with governments running huge deficits and continuing to take on more debt, including for defense.

Another negative factor for government bonds is growing competition for capital from AI companies, which is putting further upward pressure on yields. 

So while yields may correct lower in the short term on geopolitical developments, we shouldn’t expect them to return to pre-war levels until other fundamental problems are resolved. 

That’s why, for now, it’s worth being cautious with long-term bonds from heavily indebted countries like France, as well as with the EUR/USD pair. And when it comes to corporate bonds, the higher the benchmark cost of borrowing, the more expensive it is for companies to take on debt, so it makes sense to focus on companies with stronger balance sheets. 

The bond market remains under pressure as there’s still no progress in the Iran-US talks, with Tehran saying it won’t soften its demands after Trump rejected its proposal to reopen the Strait of Hormuz in exchange for lifting the US blockade and restrictions on Iranian ports. 

Hence, oil prices jumped on Monday, with the US 10-year yield rising 7bps to 5.23%, its highest since 2007, while the 30-year yield hit a more than 22-year high. 

Now, once the 10-year Treasury yield breaks above 5.25%, bonds could lose their defensive role as stocks and bonds move in tandem, forcing portfolios to recalibrate and adding to market volatility. 

And a priori, there’s little chance of sentiment returning without a resolution on Iran. 

With PMIs still pointing to solid growth, the Cleveland Fed forecasting 5.1% annualized growth this quarter, and the AI boom driving demand for both capital and labor, the Fed has little reason to turn dovish. No wonder rate swaps now price roughly 100bps of Fed hikes over the next year, taking rates from 3.75%–4.00% to 4.75%–5.00%. 

The Treasury buyback program probably won’t help much either, as it mainly swaps older, less liquid bonds for newer ones without reducing overall debt, while new supply keeps coming, with the Treasury selling $70bn of five-year notes at a 5.03% yield after offering a premium to attract demand. 

As for what happens if bond yields keep rising, the short answer is that risk appetite could weaken, putting further pressure on equities and crypto, including Bitcoin and Ethereum prices.

The good news is that the worse markets perform and the closer we get to the US midterms, the more incentive Trump may have to pull a mega TACO and sign a deal with Tehran, even if it’s far from ideal. If that doesn’t happen, it’s hard to see AI developments saving markets this time. 

The question heading into the Fed’s September meeting was whether Kevin Warsh would go against the economic data. Had he done so, markets might have seen it as the Fed losing its independence to political pressure, hurting its credibility and weighing on the dollar, judging by the DXY chart, and Dow Jones futures.

However, all FOMC members voted in favor of a 25-basis-point hike, bringing the target range to 3.75%-4.00%, the highest level since July 2023. And there were two reasons for this.

First, the U.S. economy remains strong, with 162,000 nonfarm jobs created in August, above expectations, which ranged from 53,000 to 65,000, and TD Bank estimates real GDP growth of 2.8% in the third quarter, with momentum likely to continue into the fourth quarter.

Second, inflation shows no signs of easing: year-over-year inflation held at 3.4% in August, while prices rose 0.4% from the previous month, following a 0.1% increase in July. Actually, the numbers could worsen, as the U.S. started the week with diesel prices above $6.50 per gallon, surpassing the 2022 high in nominal terms amid supply disruptions from the war between the U.S. and Iran and Ukrainian attacks on Russian refineries.

That matters because diesel is not just a problem for drivers but is also a key input for freight, agriculture, electricity generation, rail transport, etc. Hence, the Fed’s rate path is now higher than expected, with rates projected 0.3 pp higher in 2026 and 0.5 pp higher in 2027–2028, with four FOMC members seeing another 50 basis points of hikes, while the remaining 12 expect at least one more hike this year. 

For now, though, markets aren’t particularly worried about the hit to the economy and are focusing on the fact that they finally have some clarity, at least on monetary policy. But the longer energy issues persist, the harder it will be for the stock market to remain immune.

U.S. inflation data for August was broadly in line with expectations, with headline CPI up 0.4% from the previous month and 3.4% from a year earlier, while core inflation came in slightly above forecasts at 0.3% and 2.4%. Though it still showed that inflation pressure remains high, according to the economic calendar, and coupled with a strong labor market, investors are pricing in a +80% probability of a rate hike at the September 16 meeting.

Rising tensions in the Middle East just added fuel to the fire, with the Saudi oil pipeline that carries crude through the Red Sea shut as a precaution after attacks, according to the Energy Ministry. 

And this week, things got worse, with oil prices climbing above $107 a barrel after an attack on a vessel in the Strait of Hormuz, the Saudi pipeline disruption, and an escalation in attacks by Iran-backed Houthis, who reportedly seized Perim, a strategic island in the Bab el-Mandeb Strait, on September 11. 

So the case for a rate hike is strong, but there is always room for a surprise, and markets may not like it this time. 

If Fed Chair Warsh votes to keep rates unchanged, he could lose the market and his colleagues’ confidence and put dollar assets under pressure, something we got a taste of last year when Trump attacked then-Fed Chair Jerome Powell. 

And things could get even trickier if the Bank of Japan tightens policy and leaves the door open to further hikes, as a stronger yen could pressure the carry trade, where investors borrow in yen to buy higher-yielding assets like U.S. stocks, and hit tech and AI stocks again, as we saw in summer 2024.

Now, if the Fed does hike, the key will be Kevin Warsh’s speech, but since he has avoided giving any clues on monetary policy, markets may demand a higher premium for the uncertainty.

Next Wednesday, the Fed will announce its interest rate decision, and this meeting could serve as a true test of whether Chairman Worsh remains true to his mandate.

With surprisingly strong U.S. labor data for August, with 162,000 nonfarm jobs added versus expectations of just 55,000, the odds of a rate hike have risen above 60% again. If August CPI tops 3.4% headline and 2.5% core, the case for higher rates gets even stronger, especially as Worsh has signaled he will take a tough stance on inflation. 

The problem is that Trump is back in the game, pushing for lower rates and threatening to halt trade with countries where the U.S. runs a deficit. His threats haven’t worked before, but who knows, maybe this time they will. If they do, though, that would add more headwinds, especially with no solution to the Middle East crisis and trade wars flaring up again. Both the dollar index and oil prices remain highly sensitive to these geopolitical risks and incoming economic data.

As for Trump’s claim that the U.S. secured “the largest oil deal in world history” and gained control of most of Venezuela’s 65+ billion barrels of proven reserves, it’s unlikely to boost U.S. oil supplies or bring gasoline prices down anytime soon. Venezuelan crude is extremely heavy and hard to produce, while the country’s oil infrastructure needs major repairs. 

Rystad Energy estimates that restoring production to 3 million barrels a day would cost around $183 billion and could take until 2040. Even reaching 2 million barrels a day would require at least $41 billion and likely take until the 2030s.

No wonder the global bond market remains under pressure, with inflation risks still high and major central banks expected to keep policy tight. 

Now, if Worsh goes against expectations and holds rates despite all this, it could raise serious questions about the Fed’s independence and weigh on dollar assets, just like previous attacks on Powell did. 

The ceasefire between the U.S. and Iran didn’t last: the two sides exchanged strikes again overnight Monday, cutting transit through the strait to just five vessels a day. Actual volumes could be higher due to disabled identification systems, but Brent crude still climbed back above $91 a barrel, while gold prices fell, although mildly.

The Russia-Ukraine conflict isn’t getting any better either, with Russia’s Defense Ministry saying it is preparing large-scale strikes on Ukraine’s energy infrastructure in response to Kyiv’s attacks. Meanwhile, the two sides are also attacking each other in the Black Sea, disrupting grain supplies to global markets. 

And to top it all off, trade wars are back in focus, with China warning against the additional 7.5% U.S. tariff on Chinese goods, calling it protectionism and the politicization of trade, and threatening to retaliate. 

Meanwhile, the Canadian government said last week it will impose tariffs of 15%, 25% and 50% on about $20 billion worth of U.S. goods starting September 8, 2026, in response to U.S. plans to raise tariffs on Canadian cars, auto parts, and steel to 50% from January 1, 2027. 

For the economy, the main risk from all of this is another inflation spike.

By the way, the U.S. will suffer too, with the Fed’s preferred PCE inflation gauge rising 0.2% in July from the previous month and 3.7% year over year, versus expectations of 0.1% and 3.6%. 

Central banks could respond by tightening policy, pushing government bond yields higher across the U.S., Europe, and Japan, potentially weighing on riskier assets. 

The hope is that, as the U.S. midterm elections approach, the White House will make some concessions to at least bring fuel prices down and regain voters’ support. 

Over thirty times U.S. officials have claimed the standoff with Iran is about to end, and the Strait of Hormuz will reopen, but the weeks keep passing, and the rhetoric only gets worse, keeping oil prices high. 

In the latest move, Trump announced a “devastating economic operation” against Iran, which he described as economic war and unprecedented isolation, after Tehran rejected the U.S. proposal. Iran says it is ready to respond, for example, by threatening fines and the seizure of 45 tankers. 

One relief is that the U.S.-organized corridor off Oman is reportedly moving around 10 million barrels of oil a day, with more than 660 million barrels passing through since May, thus limiting the impact on the global oil market. Still, if things worsen, with the Houthis trying to close the Bab el-Mandeb Strait or Iran disrupting the route through Oman, oil could rise again and push inflation higher. 

It’s worth noting in this sense that supply disruptions and the Strait of Hormuz blockade have cut global crude inventories by around 519 million barrels between February and August 2026, or roughly 3 million barrels a day. If the decline continues, Citi expects OECD inventories could fall to around 70 days of demand by the end of 2027.

As for the forecast that oil stocks would hit critical levels in August, that didn’t account for tankers using shadow routes through the strait. Still, even with oil below $100, higher prices are feeding into the economy through inflation.

We may get a sense of how central banks plan to deal with that in Jackson Hole, Wyoming, where the Fed will hold its annual symposium from August 27, and Kevin Warsh will speak on Friday. 

It will also be worth hearing what he says about U.S. debt above $40 trillion and rising Treasury yields, which raise financing costs and make bonds more attractive than stocks, especially growth stocks.