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Over the past quarter, central banks have been tightening into the Middle East energy shock rather than hoping it goes away. However, that proactive stance is rippling through to all other major asset classes.
Proactive rate hikes
The United States (US) Federal Reserve (Fed) raised the funds rate by 25 basis points to 3.75%-to-4% on 16 September, its first hike since July 2023, in a unanimous decision under Fed Chair Kevin Warsh, despite White House pressure for lower rates. The European Central Bank (ECB) had lifted its deposit rate to 2.50% six days earlier, and the South African Reserve Bank (SARB) followed on 23 September with a unanimous 25-basis point increase to 7.25%.
None of these decisions was a response to overheating demand. Each was designed to stop the energy spike that followed the escalation of the US-Iran conflict from feeding into wages, inflation expectations and broader pricing, the mechanisms through which a temporary oil shock becomes a persistent one. With Brent up roughly 70% this year and back above $100/barrel on 1 October, policymakers have judged that waiting for evidence of those second-round effects carries more risk than acting before they arrive.
Bond yields tighten the noose
The bond market has done more of the tightening than the central banks themselves. As at the time of writing, the US Treasury 10-year bond was trading near 5.30% and the 30-year was near 5.65%, levels last seen in 2002. Yields in Germany, France and the United Kingdom (UK) sit at 17- to 19-year highs and the 10-year Japanese Government Bond yield has moved above 3%. When the benchmark against which every other asset is priced resets this far, the cost of capital rises for governments, companies and households at once, and the liquidity that was abundant in the first half of the year has started to thin.
The rapid rise in rates has altered the way markets process information. While rates were falling or expected to fall, risk assets could absorb disappointing data because the prospect of cheaper money cushioned the impact. With the Fed’s September projections placing the median funds rate at 4.1% by year-end, implying a further hike before December, that relationship has inverted. Now, weak data will have no policy response to support it, while strong data raises the probability of additional tightening.
Tech equities at record highs
Global equities nonetheless remain within 2% of their record highs, and the explanation lies in earnings rather than sentiment, with S&P 500 earnings projected to grow by more than 30% this year, a pace unprecedented outside post-recession recoveries. Growth of that scale can absorb a rising discount rate, but only where it is concentrated, in this case in technology, which is why the resilient index level conceals the narrowing market beneath it.
The tech-heavy NASDAQ 100 edged higher on 29 and 30 September while the equal-weight S&P 500 and small caps fell, with new lows outnumbering new highs by a wide margin throughout. Leadership came from the small group of AI beneficiaries whose earnings are growing fast enough to outpace higher rates, illustrated by Micron’s quarterly revenue of $54.2 billion against $11.3 billion a year earlier. How the AI infrastructure development is funded matters as much as its scale, because Nvidia pays for its buybacks, dividends and equity-stakes in its own customers from internal cash flow, while the hyperscalers buying their chips increasingly issue debt to finance data centres, so those higher yields fall on the buyers of AI capacity rather than its suppliers. The strength, however, is far from global, since South Korea’s KOSPI fell almost 20% in the third quarter, its worst quarter since the pandemic, as chipmakers gave back part of the earlier surge.
The Fed’s response
Many investors have taken comfort in the assumption that Washington cannot absorb the financing costs of a 10-year yield above 5% for long, with federal debt above $40 trillion and a budget deficit of around $2 trillion a year. That intervention has already been attempted. US Treasury Secretary Scott Bessent expanded buybacks of long-dated bonds in August, tripled the size of the operation to $6 billion on 9 September and signalled a fiscal consolidation initiative, yet the 10-year crossed 5% on 14 September for the first time since 2023 and has continued higher. Bessent has acknowledged that the Treasury cannot change the equilibrium price of government debt and can only slow disorderly moves, and the market has treated the buybacks accordingly, as a liquidity measure that leaves inflation and fiscal concerns untouched, driving investors to demand more compensation for holding longer-term US Treasury bonds.
Walking the balance
Markets are consequently suspended between outcomes, waiting to see which pressure gives way first. Energy was the original catalyst, yet the bond selloff deepened in late September even on days when oil fell, which suggests the driver is shifting from the inflation outlook driven by oil prices towards the volume of government debt that investors are being asked to absorb. A lower oil price alone may therefore no longer be sufficient to bring relief to US bond markets.
Market moves
Bonds
The US 10-year Treasury yield settled around 5.33%, having touched 5.34% intraday yesterday – its highest level since April 2002 – while the 30-year reached roughly 5.67%, also its loftiest level in 24 years. The driver was a hawkish repricing after Minneapolis Fed President Neel Kashkari stressed inflation remains “too high” despite the softer PCE print. The oil spike compounded inflation anxiety. Markets have sharply cut their expectations of a near-term cut. This is the gravitational centre of every other asset today – long-term assets are being punished, the dollar is in demand, and risk assets are being forced to justify valuations against materially higher US interest rates. Today’s US Non-Farm Payrolls report will be a deciding factor for the next move in US bond yields.
Germany’s 10-year Bund closed near 3.62%, up about four basis points, dragged higher by the global move and a serious eurozone inflation problem with September Consumer Price Index (CPI) accelerating faster than expected in France, Italy and Spain on elevated fuel and gas costs. That hardens the case for the ECB to hold restrictive policy for longer and caps any rally in core European long-term bonds. The Bund’s relatively contained level versus Treasuries and Gilts reflects its safe-haven pull within Europe, but the direction of its yields is unambiguously higher, which will tighten financial conditions resulting in a softening growth outlook.
The UK’s 10-year Gilt pushed to roughly 5.48%, up around five basis points and among the highest-yielding major developed market benchmarks, lifted by the global yield surge, energy-cost inflation and ongoing Gilt-supply pressure. The level underscores the UK’s persistent fiscal-and-inflation risk premium. For sterling assets this is a double-edged setup where higher yields offer carry opportunities (income earned by holding the asset) thereby encouraging buying but also signals stress within the UK’s fiscal backdrop, of which the rate-sensitive FTSE bore the brunt.
Equities
The S&P 500, the NASDAQ Composite and the Dow all closed higher on Thursday with the benchmarks holding near record highs despite the yield shock. Resilience was concentrated in semiconductors – Micron earnings beat estimates, driven strongly on data-centre demand – which offset the drag from higher interest rates and firmer oil. The flat Dow signals that cyclicals and rate-sensitive sectors are feeling the pinch while tech masks underlying fragility.
The Euro Stoxx 50 fell 1.5% to roughly 6,255 and the DAX dropped around 1% to 25,058 as the quarter opened defensively. Accelerating eurozone inflation and a stalled Middle East peace process outweighed any relief from softer US macro data. Rising Bund yields and energy-cost pressure squeezed valuations and rate-sensitive sectors. With the ECB tilted toward holding policy tight, European equities face a less supportive liquidity backdrop than their US peers, and the energy-inflation nexus is a specific headwind for the region’s import-dependent industrials.
The FTSE 100 was the standout underperformer, sliding around 1.7% to roughly 10,428, hit squarely by the combination of higher Gilt yields and oil’s second-order effects on risk appetite. Despite the index’s heavy energy weighting, which should benefit from higher crude prices, the broader rate shock and global risk-off tone dominated. The scale of the decline relative to continental peers reflects the UK’s acute sensitivity to the yield surge.
Commodities
Spot gold traded around $4,164/ounce, down roughly 0.28% on the session. The metal is being pressured by precisely the forces lifting bonds – a 24-year high in real and nominal US yields raises the opportunity cost of holding a non-yielding asset, and a dollar near its 52-week high adds a direct headwind. Gold’s failure to rally despite acute geopolitical and inflation risk is itself the signal as rates and the dollar are, for now, the stronger pull.
Crude was yesterday’s shock. West Texas Intermediate rose about 2.8% to roughly $92.96/barrel and Brent jumped around 3% back to above $100/barrel, after China suspended fuel exports for October against a backdrop of Middle East tension and uncertainty over Strait of Hormuz shipping. This is the engine behind the global inflation re-pricing – it feeds directly into CPI fears and hardens central-bank hawkishness.
Currencies
The US Dollar Index is trading around 101.72, up roughly 0.27% and sitting at the very top of its 52-week range, having printed a session high at 102. The driver is a 24-year high in US yields and a widening rate differential, which are pulling capital toward the dollar, reinforced by its safe-haven appeal amid the oil-and-geopolitics backdrop. The dollar is the fulcrum of today’s cross-asset picture and the single biggest swing factor will be the Non-Farm Payrolls report, where a strong print will likely strengthen the dollar further and a weak one will offer the dollar’s peers some relief.
The euro is trading around $1.1240/€, pinned below the $1.13/€, a technically negative signal. The widening US-euro rate gap is the dominant driver, only partly cushioned by rising European yields. Accelerating eurozone inflation is a double-edged factor supporting Bund yields but signals the stagflationary mix that keeps the single currency on the defensive.
*Please note that all information is at the time of writing.
Key indicators:
GBP/USD: 1.3198
GBP/EUR: 1.1744
GBP/ZAR: 21.99
BRENT CRUDE: $99.99
GOLD: $4,184.05
Sources: Associated Press, Fortune, Micron Technology, MUFG Research, Reuters and South African Government News Agency.
Sources: Associated Press, Fortune, Micron Technology, MUFG Research, Reuters and South African Government News Agency.