Fed Turns Hawkish (31 August – 4 September)

Global markets entered the week with renewed focus on Federal Reserve tightening after Chair Kevin Warsh used his Jackson Hole address to push back against expectations that US inflation pressures were fading. The Dollar Index held near 99.6 after Friday’s sharp advance, while Treasury yields moved higher and precious metals retreated. Markets raised the probability of a September Fed rate hike to 57% from 40% a week earlier as Warsh reiterated the Fed’s commitment to returning inflation to its 2% target.

Geopolitical risks also returned to the foreground after the US military struck Iranian rocket launchers that were reportedly preparing to mine the Strait of Hormuz, marking the first such attack in more than a month. Brent crude moved back toward $90, adding another potential source of inflation pressure. At the same time, European inflation data strengthened ECB tightening expectations, while markets increased bets on a September Bank of Japan hike as yen weakness and domestic inflation remained concerns.

Market Drivers & Catalysts

• Warsh Reinforces Hawkish Fed Outlook: Fed Chair Kevin Warsh said inflation has not slowed meaningfully and reiterated the Fed’s commitment to its 2% target, driving September rate hike expectations to 57% from 40% the previous week.
• Hormuz Tensions Return: The US military struck Iranian rocket launchers reportedly preparing to mine the Strait of Hormuz, marking the first such attack in more than a month and pushing Brent crude toward $90 per barrel.
• Hormuz Oil Flows Continue: Despite renewed tensions, approximately 6–8 million barrels of oil per day continue to pass through the Strait of Hormuz.
• ECB Tightening Expectations Rise: Higher French and Spanish inflation strengthened expectations for another ECB increase, with markets pricing the deposit rate at 2.80% by March and assigning a 60% probability of it reaching 3%.
• BOJ Hike Bets Strengthen: Markets now price an 87% probability of a September BOJ rate increase to 1.25%, compared with only 23% before the July meeting.
• US Economic Resilience: July personal income increased more than the expectations, while durable goods orders recorded their strongest increase since April, adding to evidence that parts of the US economy remain resilient despite restrictive borrowing costs.

Fixed Income

• US 10-Year Treasury Note Yield: The US 10-year Treasury yield climbed to 4.73% after Fed Chair Kevin Warsh warned that inflation has not meaningfully slowed and said additional progress is necessary to return inflation to the 2% target. Warsh described interest rates as the Fed’s “predominant tool” and argued that recent PCE and CPI figures showed little meaningful improvement. The comments provided additional policy guidance after criticism that the Fed had offered limited direction. Markets now assign close to a 50% probability of a September rate hike.
• UK 10-Year Bond Yield: UK 10-year gilt yields remained slightly above 5% as investors balanced Warsh’s hawkish remarks against falling Brent crude prices. Lower oil eased some UK inflation concerns and pushed expectations for further Bank of England tightening further into the future. Markets currently price 24 basis points of BoE tightening by December, although a softer labor market continues to encourage a cautious near-term approach and expectations for additional action extend into 2027.
• Japan 10-Year Government Bond Yield: Japan’s 10-year government bond yield climbed above 2.9% as expectations for further Bank of Japan tightening increased. Markets now assign an 87% probability to a September hike to 1.25%, sharply higher than 23% before July’s meeting. Former BOJ board member Seiji Adachi expects increases in September and January and warned that delaying action could renew pressure on the yen. Deputy Governor Ryozo Himino also emphasized the need for inflation vigilance. Japan’s unemployment rate fell to 2.4%, while Tokyo inflation reached a five-month high.
• Germany 10-Year Bund Yield: Germany’s 10-year Bund yield moved above 3.25%, reaching its highest level since March 2011, as persistent inflation concerns outweighed the effect of lower oil prices. Stronger French and Spanish inflation reinforced expectations for a September ECB increase, while markets price the deposit rate at 2.80% by March. ECB meeting minutes and reports also indicate that a September hike is increasingly likely, although the outlook for subsequent tightening remains less certain. Hawkish comments from Warsh added further upward pressure to global yields.

Commodities

Gold held near $4,460 per ounce after falling more than 3% as Warsh’s Jackson Hole remarks revived expectations for a September Fed rate increase. Warsh argued that inflation was not easing significantly and reiterated the central bank’s commitment to the 2% target, while also suggesting that financial conditions were not particularly restrictive. Markets raised the probability of a September hike to 57% from 40%. Higher oil prices following US strikes against Iranian forces near Hormuz added another source of inflation pressure. Despite the pullback, gold remains on track to gain more than 10% in August.

Silver traded near $66.4 per ounce after losing more than 4% as Warsh’s hawkish comments increased expectations for additional Fed tightening. September hike odds climbed to 57% from 40%, while the Fed Chair reiterated that inflation was not easing significantly and reaffirmed the 2% inflation target. Higher oil prices following the US action against Iranian forces added pressure through renewed inflation concerns. Silver nevertheless remains on track for a gain of more than 15% in August.

Currencies

• U.S. Dollar Index (DXY): The Dollar Index held near 99.6, extending Friday’s sharp advance after Warsh’s Jackson Hole comments strengthened expectations for further Fed tightening. September rate hike odds increased to 57% from 40% the previous week after Warsh warned that inflation was not slowing meaningfully. An upward revision to University of Michigan consumer sentiment also supported the dollar. Renewed tensions around Hormuz provided additional safe-haven demand as oil prices climbed following US strikes against Iranian forces.
• Euro: The euro declined toward $1.16, its lowest level since August 19, as Warsh’s hawkish comments strengthened the dollar despite firmer European inflation figures. French and Spanish inflation accelerated, supporting expectations for further ECB tightening. Markets now expect the ECB deposit rate to reach 2.80% by March and assign a 60% probability to a move to 3%.
• British Pound: Sterling fell toward $1.35, its weakest level since August 19, as the stronger dollar outweighed domestic factors. Falling Brent crude reduced UK inflation concerns and pushed some expectations for additional Bank of England tightening into 2027. Markets still price around 24 basis points of tightening by December, although weakness in the labor market is expected to keep the BoE cautious in the near term.
• Japanese Yen: The yen weakened beyond 160 per dollar, approaching a one-month low as higher US rate expectations widened the policy gap between the Fed and BOJ. September Fed hike odds rose to 57% from 40%, while markets also expect the Bank of Japan could increase rates in September. The yen has now surrendered more than half of the gains achieved following July’s joint intervention, with wide interest rate differentials, fiscal concerns, and elevated oil prices continuing to weigh on the currency.

Economic Data Highlights

• Federal Reserve Policy Outlook: Fed Chair Kevin Warsh said underlying inflation is not slowing and reaffirmed the PCE Price Index as the Fed’s main inflation gauge following earlier ambiguity. The Fed kept rates at 3.50%–3.75% in July for a fifth consecutive meeting, with three policymakers dissenting in favor of an increase. Warsh also emphasized reducing the size of the Fed’s balance sheet and continued to criticize the use of forward guidance.
• US Payroll Benchmark Revision: Preliminary BLS revisions showed that the US economy added 79,000 fewer jobs than initially estimated during the 12 months through March 2026, representing a 0.1% downward adjustment. Retail trade recorded the largest downward revision at 154,600 jobs, followed by education and health services and wholesale trade. Manufacturing employment was revised lower by 67,000. Transportation and warehousing received the largest upward revision at 135,100, followed by government, information, and financial activities.
• US Personal Income (July): Personal income increased 0.4% to $27.115 trillion, accelerating from June’s 0.2% increase and exceeding expectations for another 0.2% gain. This marked the ninth consecutive monthly increase. Disposable personal income rose 0.5%, supported by higher private wages, Medicaid and Medicare-related government benefits, and personal dividend income.
• US Durable Goods Orders (July): Durable goods orders increased 1.1% to $339.3 billion, marking the strongest gain since April. Transportation equipment and defense and nondefense aircraft led the increase, while capital goods, primary metals, and machinery also recorded gains. Computers and electrical equipment declined. Excluding transportation, orders increased 0.4%, below expectations, while the business investment proxy rose 0.2%, also missing forecasts.

Macro Calendar Highlights

• US ISM Manufacturing PMI
• ISM Manufacturing Prices
• JOLTS Job Openings
• US ADP Employment Change
• Factory Orders
• Crude Oil Inventories
• US Initial Jobless Claims
• S&P Global Services PMI
• ISM Services PMI
• US Nonfarm Payrolls
• Unemployment Rate
• Average Hourly Earnings