Global bond markets finally found their footing last week, and currency markets followed suit.
The 10-year Treasury yield touched a fresh 24-year high on Thursday, but it ended the week slightly lower, while French bonds recovered some of their recent losses. The US Dollar Index had been grinding steadily higher due to the rout, but it ended the week close to unchanged. Equity investors took the calmer backdrop as a green light, and the S&P 500 set fresh record highs midweek despite long-term yields sitting near multi-decade peaks. We would caution against reading too much into a single week of calm. None of the fiscal worries in France or the UK have been resolved, and the equity rally looks increasingly disconnected from the rising cost of long-term borrowing. For now, however, bonds appear to have dropped sufficiently to entice some bargain hunting.
This week brings a heavily calendar that will test the new calm in bond markets. US CPI inflation for September on Wednesday is the focus for markets. Fed Chair Warsh speaks on Thursday afternoon, alongside Waller, Bowman and Hammack earlier in the week. These are the last scheduled Fed communications before the blackout period begins on Saturday ahead of the 27-28th October meeting. In the UK. We get August GDP on Thursday and an unusually long list of MPC speakers, ending with Governor Bailey on Friday. Lagarde and Schnabel both speak on Wednesday. The IMF annual meetings run all week, and the US bond market is closed on Monday for Columbus Day.
GBP
The sterling rally against the common currency continues to hit fresh 16-month highs, with the pound also stabilising against the US dollar. As in the previous week, this was more about the euro’s troubles than about any good news in Britain. Markets increasingly expect the Bank of England to raise rates at its 5th November meeting and we concur, though we still see this as no more than a one off insurance hike. We will this week hear from MPC members Mann, Greene and Pill - the three members who voted for a hike in September.
Given the renewed focus on fiscal sustainability among bond investors, this month’s Autumn Budget remains a critical risk for both gilts and the pound, and Thursday’s GDP print is unlikely to change that. With much of the government’s fiscal headroom eroded due to the spike in yields, we see additional tax increases as inevitable even before we get to Burnham’s spending ambitions. We see the fallout in markets as dependent on whether Healey can keep damage to a minimum, while convincing markets that future spending plans won’t come at the expense of debt sustainability. The room for error is small, however, and risks to UK assets appear skewed to the downside heading into the fiscal event.
EUR
After a rough start to the week, French sovereign bonds and the euro both stabilised and bounced back modestly in tandem. Presidential frontrunner Le Pen offered reassurances last week on reining in government spending, which markets appear to have welcomed. Yet the protests and marches across the country in recent days in support of higher education funding show how hard it will be to strike a balance between shoring up the public finances against keeping the voter base on side. We remain cautious given prospects for serious fiscal consolidation in France in the long-run remain dim ahead of next year's presidential elections.
Markets have scaled back their ECB rate hike expectations as a result of the turmoil in France, which has offset some of the relief for the euro from the calming in global bond markets. ECB officials Lagarde and Schnabel have a chance to reshape that impression this week ahead of the 29th October meeting, which looks highly likely to deliver a pause. Absent that, the euro’s fate remains tied to French spreads.
USD
The FOMC minutes read as hawkish last week, but they predate the soft September payrolls print and the modest inflation reads since then. We continue to think the Fed will hold rates this month, since we expect a moderate (i.e. 0.2% or less) monthly core print in this week's inflation report for September. However, any upside surprise there would quickly lead markets to reprice higher the chances of an October hike and may push the dollar to break out of the range that has held since the summer of 2025.
Our base scenario calls for continued stabilisation in bond markets and a contained spillover effects from energy price spikes, which would remove a key support from the recent dollar rally. Market participants will also have one eye on the midterm elections in early November, which could also be mildly bearish for the dollar should gridlock in Congress limit the ability of the US government to pass major spending or tax initiatives.
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