By Mike Dolan
Aug 14 (Reuters) – Even though we’re slipping inexorably into the summer holiday doldrums on world markets, bond anxiety was once again a theme of the early part of this week, threatening to spoil the party for stock markets basking in the glow of bumper, AI-infused second-quarter earnings.
All’s well that ends well, however – at least for this week. Two less-than-scary updates on U.S. consumer and producer price inflation for last month appeared to be enough to take the sting from jumping Treasury yields. The largely expected tick lower in both annual inflation gauges offers Federal Reserve officials some cover if they want to avoid an interest rate rise as soon as next month.
The Fed futures market scaled back chances of a hike in September to just one-in-three from what was a coin toss before the price reports. Encouraged also by decent demand at new debt auctions of some $125 billion this week, Treasury yields unwound most of their recent rise, with the two-year yield hitting its lowest in a month.
Problem solved? Well, not quite.
For a start, Treasury was forced to sell new 10-year notes at their highest rate at auction in 19 years this week and 30-year bonds at their highest rate in 25 years on Thursday. Meanwhile, the average 30-year fixed mortgage rate is running as high as 6.7%.
Hopes that July’s high oil and energy costs would quickly dissipate on moves to end the Iran war have run aground again this month. Brent crude prices probed $90 per barrel this week – and average U.S. retail gas prices are still above $4 per gallon – as it became increasingly clear that the two sides in the war are still far apart.
Iran continues to assert control over the Hormuz strait and sporadic attacks continue in the Gulf and Red Sea, while the U.S. said on Thursday it could maintain a blockade on Iran’s ports indefinitely. Importantly, transits through Hormuz fell this week and less crude may be escaping the Gulf than the U.S. believes.
If that were the only issue aggravating inflation, it may be tempting to look through it.
But after the week’s relatively well-behaved inflation reports, the Fed now has to look to the personal consumption expenditures (PCE) price measure that it explicitly targets. With key components from this week’s data mapped into that, the Cleveland Fed’s inflation “nowcaster” still has PCE inflation running at 3.7% for both July and August – with core PCE running at 3.3%.
So, not only have these PCE measures been above the Fed’s 2% target for almost six years, they have both been above 3% for all of this year so far.
The doves cling to hopes that tariff-related goods price rises are about to fall out of inflation indexes, downward PCE data revisions are on the way, the labor market is softening and AI promises productivity miracles.
The hawks see overly loose financial conditions that suggest the Fed is no longer restricting activity, rising corporate leverage, tech sector product tightness, a falling jobless rate and – above all – fraying credibility in the Fed’s willingness to get inflation back to its target.
Cleveland Fed boss Beth Hammack, who voted to hike at the last meeting, said the Fed needed to act now to achieve its target. “If it takes us another three or four years to get there, is that OK?” she asked rhetorically on Thursday. Boston Fed chief Susan Collins, who’s not a voting policymaker this year, told the Financial Times she would be prepared to back a rate move this month.
But the real psychodrama hanging over the Fed happened at the tail end of last week, when President Donald Trump sent a letter to Fed Governor Lisa Cook that demanded she clear her name over disputed mortgage fraud allegations or be fired.
Even though the Supreme Court ruled in June that the president could not fire a Fed governor without proof of wrongdoing, the timing of Trump’s new deadline is widely seen as reopening pressure on the central bank and casts fresh doubts over its independence from politics.
Finally, one more thing hanging over Treasuries is the chance that prolonged Japanese intervention to prop up its ailing yen could see it sell U.S. bonds to fund that. That story went quiet this week after the recent historic joint action from Washington and Tokyo to shore up the currency, but there’s pressure building on the Bank of Japan to reinforce the action with higher interest rates.
Reuters sources said on Friday that the BOJ would hike next month and possibly accelerate tightening thereafter.
Even if debt markets are still wobbly, stocks had a sunnier week – recapturing record highs on Wall Street as overall annual earnings growth in the second quarter topped 50% for S&P 500 companies – and even hit 23% in Europe.
Once again, the eye-catchers stateside were companies at the center of the AI boom. Shares in both CoreWeave and Super Micro Computer surged about 20% on Wednesday, a day after their earnings beats underscored the scale of the AI infrastructure buildout.
With equity indexes back in rude health and volatility gauges subdued, speculation about long-awaited AI IPOs has gone up a gear again. The Financial Times reported that Anthropic investors are hoping and praying for a listing with a valuation as high as $2 trillion in October.
If that transpired, it would be the biggest IPO ever, eclipsing the value of SpaceX after its June offering – much like the sun was momentarily eclipsed in Europe this week!
And the macroeconomic impact of the AI transformation and capex whoosh – noticeable in inflation and jobs data, even if still relatively small – is not confined to the U.S.
Britain challenged the long-lingering narrative about its struggling economy with an unexpectedly strong GDP reading for June and quarterly growth figures that showed it was the fastest-growing G7 economy for the second quarter in a row this year.
With annualized growth of 2% through the first half, Britain’s Office for National Statistics said the information and communications sector contributed to almost half of the 0.4% gain in the second quarter.
Barring new developments in the Gulf, next week will likely see the summer lull deepen, with the Fed’s Jackson Hole symposium and Nvidia’s earnings not coming until the week after.
Until then, markets will pore over the minutes of the Fed’s split meeting last month and a smorgasbord of economic updates from U.S. industry, business surveys and housing, as well as a sweep of Chinese macro data and inflation numbers from across Europe.
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(By Mike Dolan)
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