Markets are stagflation-prone due to rising oil prices, rates and yields
As a result, the Middle East war has pushed up energy costs and global borrowing rates. This is pushing markets and economies towards a period of potentially damaging high inflation and slow economic growth.
Stocks are still near record levels, and the economy is growing despite the massive spending on AI. Oil and gas prices have risen steadily, as has the global bond yields.
A growing number of metrics indicate that fragility is creeping into the system.
"Up to now, the story has been about commodities and rates. This has not been a story about equity and credit. Chris Jeffery said that the rising borrowing costs, energy prices and rates are causing him to be concerned about equity and credit.
PUMP IT UP
As intensifying attacks in the Middle East threaten to disrupt more supply routes, oil futures have returned above $100 per barrel. The derivatives markets shows that traders don't expect a near-term drop in price.
Investors bet the most on Brent crude reaching $100 by the end December. Options to sell it for $60 are close behind, underscoring the current extreme uncertainty.
Not just crude. Jet fuel, diesel, and European natural gas are all at record highs.
Polymarket, an online prediction market, shows that users only give a 18% chance of reopening the Strait of Hormuz by December.
Expectations of Inflation
Inflation is increasing again after a summer of decline. In August, the headline inflation rate in the U.S. was 3.4%, with gasoline prices rising 3.9%.
Europe has the same story. The annual inflation rate in the Eurozone increased to 3.3% from 2.9% in?July, which is well above the ECB target of 2%, mainly due to energy. In the UK, inflation reached a five-month peak of 3.1% in august.
The European Central Bank increased its inflation expectations earlier this month to an average 2.5% next year.
Swaps show that inflation in the Eurozone is projected to be at around 3,5% next year, and only 2.4% five years later. The U.S. inflation expectation for next year is close to 2.5% and will not change much over the next five years. .
ENERGY IS DRIVING RATE BETTING IN INCREASING WAYS
The war has completely changed the outlook of global interest rates. Markets and economists had previously expected that the world's biggest central banks would either hold rates or reduce them.
The traders now expect the European Central Bank to increase rates by almost one full point over the next 12 months, and the Federal Reserve will raise interest rates at least twice more after the 25-bp hike on Wednesday.
Energy is the main factor that influences their rate outlook.
The Bank of England left rates unchanged on Thursday, but stated that it expected UK inflation to reach 4% by 2027 - twice its target. This is up from the previous forecast of 3.2% in late 2026. Meanwhile, the Bank of Japan will likely raise rates on Friday to a new 31-year-high, with additional increases priced in.
GROWTH HEADWINDS BUILDER
The economies of countries have risen above the headwinds this year.
PMI scores, closely watched measures for the private sector, showed solid growth in Europe and the U.S. in July and August. This week, data showed that UK retail sales in August and UK growth in July exceeded expectations.
The stock market has been boosted by this resilience. According to LSEG data, second-quarter earnings of S&P 500 firms are expected to be up 53% on a year-over-year basis.
Energy prices are expected to remain high, and the global bond saleoff has driven up the yields on government bonds, setting the tone for borrowing rates around the world. The average 30-year mortgage in the United States is now at its highest level since June 2025, above 6.7%.
Investors are beginning to doubt the sustainability of AI's billions in funding.
CASH-STRAPPED
The consumer is increasingly at risk. Fuel prices have risen, and household bills will likely rise this winter, particularly in Europe where the storage levels for this time of the year are the lowest they've been in 15 years. The cost of borrowing and mortgages is up, and wages are not keeping pace.
Investors anticipate a slowdown. Consumer discretionary stocks in the United States have been the worst performers so far on Wall Street this year. They are down nearly 6% compared to the S&P which is up 10%. The contrast is even more stark in Europe. Consumer discretionary stocks have fallen 17% in this year, ranking second worst after luxury. The STOXX 600 has gained 7.5%.
As interest rates rise, consumers are more likely to spend than save. This further stifles the domestic economy.
(source: Reuters)
