Author: Igor Kuchma

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.

Weak July labor data, with 23,000 jobs lost and major downward revisions to previous months, boosted U.S. stocks, including the Dow Jones index, on hopes the Fed won’t raise rates.

That confidence grew as CPI fell to 3.4% year over year in July from 3.5% in June, Core CPI fell to 2.5% from 2.6%, and PPI came in below expectations, flat monthly versus +0.2% expected and down to 4.7% year over year from 5.5% in June. 

And yet, the U.S. 30-year Treasury yield hit 5.216% at auction, its highest since 2001. Why?

Investors are still worried inflation could stay sticky as the situation in the Middle East remains unresolved, while the U.S. faces a huge deficit and rising debt. Meanwhile, USDJPY has climbed back above 159 despite joint U.S.-Japanese intervention, fueling fears that Japan could sell Treasuries to support the yen.

The problem is that higher Treasury yields can quickly push up mortgage rates, car loans, etc., putting more pressure on the economy and ultimately financial markets.

Adding to the pressure, an El Niño that could be one of the strongest on record may cause major losses, alongside the growing U.S.-China AI competition. If Z.ai’s GLM-5.3 outperforms GPT, Claude, and Gemini, it could put further pressure on chip stocks. 

As for what could move markets this week, Wednesday is the deadline for a temporary CUSMA/USMCA deal. Without an agreement, the U.S. could impose 50% tariffs on around $20 billion of Canadian exports.

Washington could also push Iran into unprecedented economic isolation, with China and India potentially caught in the crossfire for buying and transporting Iranian oil, adding more pressure to an already tense geopolitical situation. 

Last Friday’s US jobs report was hardly encouraging: the economy lost 23,000 jobs in July, with 53,000 fewer in the public sector and 30,000 more in the private sector, while previous months were revised down by 103,000.

The unemployment rate fell from 4.2% to 4.1%, but not because more people found jobs: the labor force participation rate fell to 61.4%, while the employment rate dropped to 58.9%.

So the economy is deteriorating, yet stocks are hitting new highs. Why?

Because the Fed has a dual mandate: 2% inflation and maximum employment. Its main tool is interest rates. When the economy weakens and people lose jobs, the Fed cuts rates to support growth, and vice versa.

So, after the weak jobs data, markets sharply cut the odds of a September hike, from nearly 60% to 46%.

Add strong earnings momentum, with 88% of the S&P 500 now reported, 86% beating earnings estimates and 76% beating revenue estimates, plus the US intervention to stabilize the yen, which temporarily eased Treasury liquidity concerns, and it is hardly surprising that the S&P 500 and Dow hit new highs. 

Falling oil prices, on hopes of easing tensions in the Middle East, and increased traffic through the Strait of Hormuz might have helped too. The only problem is that, beyond the positive rhetoric, there is still no real progress toward ending the conflict. 

The last piece of the puzzle is this week’s July inflation report. With headline CPI expected at 3.4% and core CPI at 2.5%, a core reading of 2.3% or lower would strengthen the case for a more dovish Fed, potentially pushing indices and gold higher.

It’s also worth watching Thursday’s producer prices and Friday’s retail sales, as well as preliminary University of Michigan consumer sentiment data. Remember, worse economic data would actually be better for markets right now. 

The Fed, the Bank of England, and the Bank of Japan all left interest rates unchanged, but that does not mean the meetings had nothing to offer.

Starting with the Fed, the key takeaway wasn’t that it kept rates at 3.5-3.75% as inflation eased in June, with headline inflation falling 0.1% month-on-month and the annual rate to 3.7% from 4.1%, but that three members voted for a rate hike, showing pressure inside the central bank is building. And this is not the best news for the S&P 500, Nasdaq, or Dow Jones.

Looking ahead to September, markets are pricing in more than a 60% chance of a rate hike as inflation risks persist, driven by high energy prices, the unresolved Middle East conflict, and tariff wars back on the table. As for the Fed’s outlook, Kevin Warsh has not provided forecasts, although he said the central bank does not have a magic ability to bring inflation down quickly.

Similar story with the Bank of England: three of nine members voted for a 25-basis-point hike, up from two at the previous meeting, suggesting uncertainty remains. Now, taking into account that its more moderate inflation outlook compared with April relies on lower oil and gas prices, which has yet to happen, the possibility of another rate hike remains alive.

Finally, the Bank of Japan also kept rates at 1%, but warned that core inflation could exceed its target, leaving the door open to future hikes. The problem is that its room to raise rates is limited and unlikely to fully offset inflation risks or support the USD/JPY pair.

That’s why the regulator sold $58.97 billion in its latest attempt to support the yen. Together with the U.S. Treasury, which had the Federal Reserve Bank of New York sell euros to buy yen on its behalf, the currency moved back toward 157 per dollar. But once again, this could provide only temporary relief, as the fundamentals, including higher Fed rates, have not changed.

Last week, SpaceX launched Starship’s 13th test flight, the spacecraft designed for future Moon and Mars missions. While the mission was successful, a partial engine failure during the Super Heavy booster landing burn may have damaged the launch pad and did little to help SpaceX shares, which fell to $113.50 on Monday, almost 20% below their $135 IPO price. 

And the stock may not have bottomed yet.

According to Aswath Damodaran, aka the “Dean of Valuation”, SpaceX is worth about $1.3 trillion, or almost $100 per share, assuming the AI market is worth tens of trillions, xAI faces lower margins due to competition and high costs, and SpaceX will need to spend heavily on infrastructure. Now, if the company overestimates the AI market and keeps pouring money into xAI despite weaker economics, the investment case could deteriorate even further.

Another headwind could come from upcoming lockup expirations. About 20% of insider-held shares will become available for sale two days after SpaceX reports its first earnings as a public company, potentially flooding the market with nearly 1 billion shares. For comparison, only 629 million shares were sold in the June 12 IPO. Another wave hits around August 20, when 455.8 million more shares could enter the market.

On top of that, tech sentiment has turned increasingly volatile in recent weeks.

Yet bulls aren’t backing down. Morgan Stanley, for example, said Flight 13 boosted confidence in Starship’s progress, with a successful Flight 14 tower catch seen as the next major catalyst, and kept its Overweight rating with a $300 price target versus Wall Street’s $237 average. 

As for what could drive the stock higher, positive SpaceX catalysts could trigger a short squeeze, forcing bears to cover and pushing shares higher. 

There was a theory that any major escalation between the U.S. and Iran would stay on hold until the FIFA Club World Cup was out of the way. Reality, however, had other plans — already on July 10, Trump declared the ceasefire with Iran effectively dead, and the U.S. has now been striking targets inside Iran for nine straight nights.

Hence, oil prices are back above $85 per barrel, while gold (XAUUSD) is once again trying to hold the $4,000-per-ounce level.

But could it be that things from here will only get worse now that the cup has ended?

Could be the case as over the past week alone, at least three American service members have been killed, while the Pentagon is reportedly preparing to expand its military operations across the region.

But if we look at the oil market, investors still don’t seem convinced that a major escalation is imminent — even amid reports that Yemen’s Houthi rebels have begun imposing a maritime blockade on Saudi Arabia.

Now, if the situation does deteriorate, the world could face another wave of inflation, although temporary, but significant enough to force central banks to keep monetary policy tighter for longer.

Thus, the fact that U.S. CPI fell 0.4% month-over-month in June, versus expectations of -0.1%, doesn’t necessarily mean inflation is getting back under control. July’s data could easily disappoint again. Meanwhile, Kevin Warsh has made it clear that bringing inflation back to 2% remains the Fed’s top priority and that policymakers won’t tolerate persistently elevated inflation.

As for Europe, the ECB is widely expected to leave interest rates unchanged this week. Still, it could hint at a more hawkish stance should tensions continue to rise around one of the world’s key oil shipping routes.

On the bright side, if markets do start getting nervous, we could always see another round of TACO from the U.S. president.

The ceasefire between the US and Iran is showing cracks after the two sides exchanged strikes at least three times over the past week, prompting Iran’s Islamic Revolutionary Guard Corps (IRGC) to declare that the Strait of Hormuz will remain closed until further notice — or, more specifically, until the U.S. retreats from its positions.

Naturally, oil jumped more than 8% over the week.

That renewed pressure on US Treasuries as markets priced in the possibility that the Fed may have to keep rates higher for longer — or even hike again — sending the 10-year Treasury yield up to 4.56% from 4.37% and the 30-year yield to 5.06% from 4.87% over the past two weeks. Gold, meanwhile, slipped around 2.5%.

And yet, the S&P 500 index still ended the week up more than 0.7%, while the Nasdaq added another 0.8%. How?

On the one hand, investors don’t seem convinced that this will lead to a conflict on the scale of what we saw a couple of months ago. On the other hand, there is hope for another “TACO” call from the president, pulling back whenever markets start to wobble.

Are markets underestimating the risks?

Given that Republicans’ control of the U.S. Senate has weakened following Graham’s death, the White House has every incentive to prevent this conflict from dragging on. A prolonged period of uncertainty in the region would mean higher oil prices, higher gasoline prices, and ultimately angry voters.

But of course, rationality doesn’t always prevail in geopolitics…

All eyes will now be on Kevin Warsh’s appearance before the U.S. Senate on July 15. If he doubles down on his post-Fed meeting comments, that the central bank remains committed to bringing inflation back to 2% and that the inflation outlook has become more challenging, equity indices could also turn red.