Category: Banks & Interest Rates

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What’s Driving Bond Yields?

What’s driving bond yields higher?

Is it the war with Iran, rising crude oil and diesel prices, fertilizer shortages, tariffs, expanding government deficits, semiconductor shortages, or increased AI borrowing?

All of the above expand demand for credit, reflected in rising nominal GDP growth, which competes for a limited supply of available credit.

Nominal GDP & 10-Year Treasury Yield

Credit Supply

Credit supply isn’t growing at the same rate.

Foreign investment in US Treasuries has slowed. Japan and China have both shed more than $100 billion in the 6 months to August.

Foreign Holdings of US Treasuries

Total foreign holdings of US Treasuries fell by $155 billion over the last 6 months.

Foreign Holdings of US Treasuries

Increased holdings by the United Kingdom, Canada, Belgium, Luxembourg, and the Cayman Islands partly offset declines in Japanese and Chinese Treasury holdings. However, only Canada has a trade surplus with the US. Most of the balance reflects custodial accounts in major financial centers used by sovereign wealth funds, multinational companies, insurance companies, pension funds, and hedge funds engaged in highly leveraged Treasury market trades.

Norway’s $2.3 trillion sovereign wealth fund, the world’s largest, has also proposed significant cuts to its government bond holdings. US Treasuries are its largest bond holding, and will be cut by $80 billion to $135 billion in 2027, according to the proposal by fund manager Norges Bank. An increased allocation to non-government bonds would partly offset the decline, but overall exposure to the Dollar would fall.

In addition, Europe’s largest pension fund, the Dutch ABP, cut exposure to US Treasuries in the first quarter. (Reuters)

Bank credit growth is also slowing. The quarterly increase in loans, leases, and securities held by banks fell from $400 billion in Q1 to $200 billion in Q3.

Commercial Bank Credit: Loans, Leases, and Securities

Aggregate Demand

Activity, reflected by nominal GDP, is expected to accelerate in Q3.

The GDP price deflator jumped to 4.0% in Q2 of 2026.

GDP Implicit Price Deflator

The sharp increase reflects a 1.5% rise in Q2.

GDP Implicit Price Deflator

We expect at least a similar Q3 increase of at least 1.5%, taking the annual GDP deflator to 4.6% or more.

The Atlanta Fed GDPNow model projects that real GDP will grow at an annual rate of 3.6% in Q3.

Atlanta Fed GDPNow

That would increase annual growth to 2.1% over the four quarters, with nominal GDP rising to 6.7% or more.

Conclusion

If the Fed, under new Chair Kevin Warsh, lets market forces set interest rates, we expect the 10-year Treasury yield to rise above nominal GDP growth, which we expect to reach 6.7% in Q3 of 2026. That is the typical monetary policy path prior to 2000, before lax policy measures set the US on the path to the current debt-inflation standoff.

10-Year Treasury Yield & Projected Nominal GDP Growth

If the Fed changes tack and intervenes in the Treasury market by buying Treasury securities to suppress long bond yields, it will restore the imbalance and allow inflationary pressures to build.

In the first scenario, as the 10-year yield rises further, we expect demand to contract, stocks to fall, and the economy to go into recession. That would cause long-term yields to fall as nominal GDP growth slows. A new, more stable balance would then improve long-term growth.

In the second scenario,  the Fed introduces further QE, suppressing the 10-year yield as the supply of available bonds shrinks. Nominal GDP growth would accelerate as the gap widens, driving inflation higher. Stocks and Gold would rise until the Fed is forced to tighten monetary policy to curb inflation. This second path is unsustainable and would lead to higher volatility and more extreme boom-bust swings while long-term growth suffers.

Acknowledgments

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Australian Unemployment Rate at 4.7%

Key Points

  • The Australian unemployment rate jumped to 4.7%, while the economy shed 39,000 jobs in September.
  • However, hours worked rose by 1 million in September, and job ads are recovering.

Australian employment declined by 39,300 jobs in September, according to the latest ABS report. However, the fall did not affect the underlying trend, which increased by 0.1% for the month.

Australia: Employment

The unemployment rate rose to 4.7%, up from 4.6% in August.

Australia: Unemployment

The unemployment increase is partly attributable to a 0.2% decline in the participation rate, to 66.8% from 67.0% in August.

Australia: Participation Rate

However, the latest RBA minutes noted reservations about labor force updates due to recent changes in methodology:

Members noted that considerable caution is warranted when interpreting the current official labour force data, because of methodological changes to the survey. They discussed how to interpret more forward-looking indicators of labour demand; most indicators pointed to stability in labour market conditions but others (such as some measures of job advertisements) appeared to be strengthening a little. Taken together, the staff’s judgement was that these leading indicators pointed to broadly stable labour market conditions in the near term.

Actual hours worked are less open to interpretation, rising 1 million hours in September and posting an annual growth rate of 1.3%. However, the trend has flattened, reflecting zero growth since January.

Australia: Aggregate Hours Worked

On the other hand, ANZ-Indeed Job Ads have grown by 2.0% or more in each of the last three months, reflecting an improvement in some quarters.

Australia: ANZ-Indeed Job Ads

Conclusion

We find aggregate monthly hours worked to be the most reliable indicator of the Australian labor market. While September saw an increase of 1 million hours, growth has been flat this year. Minutes of the last RBA board meeting concluded that labor market conditions were broadly stable, and the September jobs report is unlikely to change that view.

Inflation remains above target, and we expect the RBA to keep hiking rates until demand growth slows.

Acknowledgments

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Asian Stocks Plunge on Fed Rate Hike Fears

Key Points

  • Headline CPI increased to 3.7% for the 12 months to September, up from 3.4% in August.
  • Energy prices rose 20.4% year-on-year, signaling stronger inflation ahead.
  • Financial markets now expect at least a 25-basis-point rate hike in December.
  • Investors reacted to the threat of higher interest rates slowing the AI rollout, with the Philadelphia Semiconductor Index falling more than 4%, and South Korea’s KOSPI index shedding more than 8.0% in Thursday trading.
  • The IMF’s quarterly Financial Stability Report this week also highlighted the potential for market turmoil, citing a correction in AI-related asset prices, rising sovereign debt yields, and the impact of AI frontier models on cybersecurity as key risks.

The headline consumer price index increased to 3.7% for the 12 months to September, up from 3.4% in August. Core CPI (excluding food and energy) increased to 2.6% from 2.4% in August.

CPI & Core CPI - Annual

Energy prices climbed 20.4% (right-hand scale below) over the 12 months, warning of a sharp rise in CPI that tends to follow with a 1- to 2-month lag, as in 2021-2023 below.

CPI & CPI Energy - Annual

Gasoline prices remain high, at $4.33 per gallon on October 12.

EIA US Gasoline Prices

Diesel eased slightly to $6.18 per gallon on measures to ease the shortage ahead of the November midterms. However, reserve releases aren’t a long-term solution, and the Persian Gulf conflict will likely drag on into next year.

EIA US Diesel Prices

Financial Markets

Several Fed speakers have hinted that the Fed won’t raise rates at the October (27-28) FOMC meeting, but will hike again in December (8-9). The 2-year Treasury yield jumped to 4.95% after Thursday’s CPI report but has since settled at 4.70%. That is still 70 basis points above the Fed’s current target range of 3.75%-4.00%, implying at least 3 more 25-bps hikes.

2-Year Treasury Yield (CNBC)

High-yield bond spreads have jumped more than 2.0% since Kevin Warsh’s keynote address at Jackson Hole on August 28, to above 12%. Widening spreads warn of likely distress among small- and mid-cap borrowers when their current debt matures and they must roll it over at much higher rates.

High-Yield Bond Spreads

Stocks

The Russell 2000 Small Caps ETF (IWM)2 is testing secondary support at 270 on the weekly chart below, while declining Trend Index peaks signal selling pressure. A breach of 270 would indicate a correction to test primary support at 240.

Russell 2000 Small Cap ETF (IWM)

The S&P 500 remains in an uptrend, but retreated  1.1%, its largest daily loss since July, as the Philadelphia Semiconductor Index fell more than 4%.

S&P 500

A breach of primary support at 11,000 in the Philadelphia Semiconductor Index (SOX) would be a strong bear signal for stocks.

Philadelphia Semiconductor Index (SOX)

Asian Stocks

South Korea’s KOSPI index fell more than 8.0% in Thursday trading.

KOSPI Index

A sell-off in global technology hardware stocks deepened Thursday, with Asian chipmakers tracking Wall Street losses as concerns over further Federal Reserve interest rate hikes, financing of artificial intelligence investments weigh on sentiment.

South Korean chip giant SK Hynix plunged over 10%, while rival Samsung Electronics fell 7.1%.

In Japan, technology investment giant SoftBank Group tumbled 7.9%. Semiconductor testing equipment maker Advantest dropped 6.9%, while chipmaking equipment supplier Tokyo Electron lost 5.4%.

….The declines come as investors grow increasingly concerned that higher borrowing costs could weigh on the massive capital spending required to build out AI infrastructure, putting pressure on technology companies that have benefited from the AI investment boom.

Chief executives of Broadcom and Intel warned on Monday that financing could become a major headwind to the AI boom, with Broadcom’s Hock Tan saying it could be bigger challenge to AI expansion than shortages of chips or electricity. (CNBC)

Treasury Market

10-year Treasury futures caught a bid, with yields falling to 5.10% from 5.30% earlier in the month as funds increasingly flow from equities to bonds.

10-Year Treasury Yield

The IMF earlier warned in its quarterly Financial Stability Report of the potential for market turmoil, citing three salient risks that could be near-term catalysts for a sharp tightening of financial conditions:

First, although core firms in the AI ecosystem have been profitable so far—easing pressure on AI-related equity valuations—weaker or less durable investment and profitability in AI could trigger a correction in AI-related asset prices, exacerbated by rising leverage, concentrated exposures, and circular financing arrangements.

Second, resurgent inflation or fiscal concerns could trigger a sharp rise in sovereign bond yields and spark broader market turmoil given the foundational importance of sovereign bonds. High public debt and rollover risks remain unresolved, increasing the chances that a rise in yields could occur in a disorderly manner, despite stable bond market liquidity and the recent unwinding of some leveraged trades.

Third, cyber threats constitute a growing systemic risk as financial services become more digital and interconnected. For their part, frontier AI models are emerging as both powerful enablers of cyberattacks and critical defensive tools. These risks by themselves do not necessarily threaten financial stability, but they could become a systemic risk—impairments to key financial intermediation and credit provision, with serious negative economic effects—if they are amplified by financial vulnerabilities.

The report also highlighted hedge funds’ highly leveraged repo positions and pursuit of crowded trades that “could amplify market stress, with spillovers to prime brokers and broader financial markets”.

Dollar & Gold

The Dollar has strengthened on the prospect of higher interest rates, with the Dollar Index testing resistance at 103 before retracing to test new support at 102.

Dollar Index

Gold weakened on the prospect of higher interest rates and a stronger Dollar, and will likely test primary support at $4,000 per ounce.

Spot Gold

Conclusion

Financial markets are unsettled by the threat of higher inflation driving up interest rates, which could interfere with funding of the AI data center rollout. Stocks are selling off as investors move into bonds, which has lowered the yield curve by roughly 20 basis points in a few days.

South Korea’s KOSPI and Japan’s Nikkei indices are falling, and a Philadelphia Semiconductor Index (SOX) breach of primary support at 11,000 would be a strong bear signal for US stocks.

A Bitcoin1 retreat below support at 80,000 would confirm a market shift to risk-off.

Bitcoin (BTC)

The last two weeks of October are typically a precarious time for stocks, as fund managers reposition after the end of the financial year. We advise stock traders to keep stops tight and investors to adopt a defensive stance by shedding more volatile assets.

Rising interest rates and a strengthening Dollar are bearish for Gold, which is expected to test primary support at $4,000 per ounce. However, the underlying forces driving higher rates—inflation, poor fiscal management, and bond market instability— are all bullish for Gold. We remain long-term bullish on Gold and view the current sell-off as an opportunity for steady accumulation.

Acknowledgments

Notes

  1. Cryptocurrencies are the highest-risk asset class, and we analyze Bitcoin (BTC) solely to identify risk sentiment in financial markets. Our analysis is not a recommendation to buy or sell BTC, nor is it a commentary on the merits of cryptocurrency.
  2. We analyze exchange-traded funds (ETFs) to determine market sentiment towards a specific sector, industry, or commodity. The analysis is not a recommendation to buy or sell, nor is it a commentary on the merits of the particular ETF.
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Australia’s biggest recession risk isn’t interest rates | Macrobusiness

By: Leith van Onselen | MacroBusiness | 28 September 2026
Re-published with permission.

The interest rate futures market overwhelmingly expects the Reserve Bank of Australia (RBA) to lift the official cash rate by 0.25% on Tuesday.

The futures market has also priced in a high probability of two further rate hikes over the next six months, which would take the cash rate to 5.10%.

Given that mortgage payments are already taking a near-record share of household income, the prospect of two to three rate hikes has economists warning that the economy could be pushed into a technical recession next year.

While the prospect of rate hikes is indeed worrying, it is not the greatest threat to the Australian economy: fuel shortages, particularly diesel, are.

As illustrated below by Alex Joiner from IFM Investors, Australia is easily the largest importer of diesel fuel in the world:

Global diesel imports

“Australia is uniquely exposed to this diesel price shock given our reliance on imported product, which is by far the highest in the world, not as a % of GDP or per capita but outright”, Joiner wrote on X (Twitter).

“This comes as other countries have scaled back imports and Australia’s have accelerated due in part to refinery closures”.

To add further insult to injury, Sky UK posted the following chart showing that Australia has very low stocks of diesel in reserve:

Diesel stocks in reserve



Source: Sky UK

Thus, with the two straits in the Middle East effectively shut and oil flows ceasing, Australia is the most exposed economy on earth to diesel shortages.

The following chart from CBA shows what a 10% reduction in diesel supply would mean to key sectors of the Australian economy – namely mining, construction, transport, and agriculture:

Diesel fuel shortages

The economic impact would be enormous, effectively shutting down large swathes of the economy. Unemployment would also rise materially.

Even if shortages are avoided, the economy faces severe energy cost inflation, resulting in significant cost-push inflation as firms pass on higher costs.

Diesel Price Forecasts



Diesel Price Forecasts (Source: Global Energy Flow)

As a result, overall CPI inflation would rise, increasing pressure on the RBA to hike further.

Higher interest rates alongside rising unemployment would exacerbate the housing downturn, impacting consumption (via the wealth effect) and industries reliant on turnover (e.g., state budgets via stamp duty, real estate agents, mortgage brokers, banks, and retailers).

Indeed, HSBC has forecast a 13% peak-to-trough decline in capital city home values, alongside a 1% reduction in GDP growth, due to slower consumer spending and reduced housing turnover.

Thus, rising fuel prices and/or shortages, higher interest rates, and an accelerating housing downturn have left Australia’s economy facing a technical recession in 2027, alongside a deep per capita recession.

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RBA Hikes, ASX 200 Rallies

Key Points

  • The RBA hiked its cash rate target by 25 basis points to 4.6% today.
  • Monthly CPI jumped to 4.0% in August, up from 3.5% in July.
  • A further rate hike is expected at the next RBA meeting.
  • The ASX 200 rallied to test resistance at 8800.

The RBA has grown more hawkish since its last meeting, spurred by a sharp rise in diesel and petrol prices that threaten to feed through into higher prices.

RBA Cash Rate Target

The average diesel retail price increased to 286.7 cents last week, with the wholesale price rising to 273.5 cents per liter.

Australian Diesel Price

CPI jumped to 4.0% in August from 3.5% in July, while the trimmed mean held steady at 3.6%.

Australian CPI & Trimmed Mean CPI

Tradables inflation (2.9%), reflecting prices for imported goods, rose sharply on higher fuel prices. Non-tradables (4.5%) reflect strong domestic inflation for services such as rent and education.

Australian CPI: Tradables & Non-Tradables

Annual inflation of 5.7 per cent for Housing reflected rising costs for both New dwellings and Electricity. New dwelling prices rose 5.4 per cent in the 12 months to August as builders passed on higher costs for materials and labour.

Transport was the second largest contributor to annual inflation in August, rising by 5.6 per cent due to higher automotive fuel prices.

On a monthly basis, Automotive fuel prices rose 14.8 per cent in August, compared to a rise of 7.5 per cent in July. This was driven by higher world oil prices and the unwinding of the remainder of the federal governments fuel excise relief measures in August. (ABS)

Nominal GDP slowed slightly to 5.3% for the June quarter.

Australian Nominal GDP Growth

Australian bond yields, at 4.95% for the 2-year and 5.25% for the 10-year, closely shadow nominal GDP growth, indicating the RBA is maintaining neutral monetary policy.

Australian Government Bond Yields

However, private credit is still growing at an annual rate of 8.4%, well above NGDP growth, suggesting that further tightening is necessary.

Australia: Credit and Broad Money Growth

Westpac Chief Economist Luci Ellis says “the bar for a November rate hike is very low” and she now expects a further hike to 4.85%.

The ASX 200 shrugged off the rate hike, rallying to test resistance at 8800.

ASX 200 Index

Conclusion

The cure for high prices is high prices. Credit growth will likely fall if the 2-year AGB yield rises above nominal GDP growth.

Diesel shortages in the coming months could do far more damage than a rate hike.

Acknowledgments

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Something Has to Break

Key Points

  • The S&P Global US Composite flash PMI shot up to 58.4% for September.
  • 10-year Treasury yields jumped to 5.114%.
  • We expect 10-year yields to climb higher, causing a correction in stocks.
  • The S&P 500 retreated, heading for a test of support between 7500 and 7600.

The S&P Global US Composite flash PMI shot up to 58.4%, the fourth consecutive month of accelerating growth and the strongest expansion in private-sector activity since July 2021.

S&P Global Composite PMI

The move was echoed by a healthy rise in the European Union’s equivalent flash PMI to 53.1%.

S&P Global Composite PMI

The surge in economic activity boosted market expectations of further Fed rate hikes, with the 2-year Treasury yield jumping to 4.876% compared to the current Fed funds target range of 3.75% – 4.00%.

2-Year Treasury Yield

The 10-year yield broke through resistance at 5.0%, closing at 5.114%, the highest level in more than 20 years. We expect a retracement to test the new support level, but respect will likely confirm another advance. Our medium-term target is 6.0%.

10-Year Treasury Yield

The S&P 500 retreated to 7700 and is headed for a test of support between 7500 and 7600. A breach would signal a correction to test primary support at 7300.

S&P 500

The Outlook for Treasuries

The spread between the 10-year and 2-year Treasury yields is shrinking as in previous Fed rate-hiking cycles (red arrows below). A dip below zero typically precedes a recession. The dip below zero from 2022-2024 was an exception, caused by the unprecedented scale of fiscal and monetary stimulus during the pandemic.

10-Year Treasury Yield minus 2-Year Yield

The Atlanta Fed’s GDPNow model projects real GDP growth of 5.1% in the third quarter, a 3.6% increase from Q2.

Atlanta Fed GDPNow

Even without an increase in the GDP deflator, driven by rising energy prices, we expect nominal GDP to jump from an annual rate of 6.6% in Q2 to more than 10.0% in Q3.

10-Year Treasury Yield & Nominal GDP Growth

The strong divergence between nominal GDP and the 10-year Treasury yield would provide further stimulus to an already overheating economy, causing a sharp increase in inflation.

Conclusion

The Fed is trapped in an inflationary boom that will likely drive long-term yields much higher than 5.0%. Rising interest rates will increase the interest cost on the US Treasury’s $40 trillion debt, expanding the budget deficit above $2.0 trillion.

The Fed is constrained by its swollen balance sheet and will likely resist further QE to suppress long-term interest rates and assist the US Treasury.

Surging economic activity, compounded by crude oil and diesel supply shortages, is also expected to drive a sharp increase in inflation, adding to the Fed’s challenges.

Something has to break, and we are adopting a highly defensive posture, heavily overweight in Gold, short-term financial instruments, and defensive stocks with strong pricing power and stable income streams.

Acknowledgments

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Warsh Hikes While Trump Fumes

Key Points

  • The FOMC voted unanimously to hike the Fed funds rate by 25 basis points to a target range of 3.75% to 4.00%.
  • President Trump criticized the FOMC decision, demanding that the Fed slash interest rates to “1% or less” on Truth Social.
  • Backing a rate hike was a politically brave move by the new Fed Chair, Kevin Warsh, as it will likely sour his relationship with the President.
  • The Fed hike likely avoided a sharp spike in long-term Treasury yields as the bond market was growing restless over loose monetary and fiscal policy.

Fed Chair Kevin Warsh cemented his reputation as an inflation hawk, voting in support of a unanimous FOMC decision to hike the Fed funds rate by 25 basis points to a target range of 3.75% to 4.00%.

President Trump condemned the move, demanding on Truth Social that the Fed slash interest rates to “1% or less.”

“We are ‘carrying’ almost every country in the World, and that cannot go on any longer,” Trump wrote in a Truth Social post.

“LOWER THE INTEREST RATES FOR THE UNITED STATES OF AMERICA, AND FAST!” he wrote. (CNBC)

Updated dot plot projections show a strong majority of Fed officials expect another rate hike this year. Warsh did not submit a projection, but 16 of 18 participants expected at least one more rate hike in 2026, of which 4 projected 2 hikes.

FOMC Dot Plot

The 2-year Treasury yield climbed to 4.73%, pricing in 3 further rate hikes.

2-Year Treasury Yield (CNBC)

10-year Treasury yields held firm at 5.0%.

10-Year Treasury Yield

A failure of the Fed to act would likely have caused a bond sell-off, with the 10-year yield spiking upwards, reflecting bond market disappointment with perceived lax monetary and fiscal policy.

Long-term yields will likely still rise, but at a more measured pace than if the Fed’s commitment to stable prices were in doubt.

The Fed Chair gave three factors that are driving long-term yields higher:

  1. The economy is strengthening and at close to full employment;
  2. Increased competition for capital as AI hyperscalers seek to fund capital spending; and
  3. Geopolitical instability.

He did not mention lax fiscal policy, with $40 trillion of federal debt and annual deficits approaching $2 trillion a year, which we consider a fourth factor driving higher yields.

Conclusion

We may have misread the new Fed Chair as a “political animal.” He has delivered on his commitment to fight inflation despite opposition from President Trump. In doing so, he has likely placated the bond market, which was driving long-term yields higher. We still expect long-term rates to rise, but at a more measured pace.

“The era of free money is definitely over,” Kim Crawford, fixed-income portfolio manager at JPMorgan Asset Management, told the Financial Times today. “The bond market is looking for discipline.”

We expect further rate hikes if the economy continues to grow faster than existing capacity allows, fueling increased inflationary pressure.

Credit growth above 4.0% is not consistent with low inflation. A 4.0% target would be consistent with the 2.3% projected real GDP growth and 1.7% inflation (below the Fed’s 2.0% target).

Bank Credit Growth

Acknowledgments

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Fed’s Warsh Hawkish But Won’t Hike

Key Points

  • Fed Chair Kevin Warsh’s keynote speech at Jackson Hole had a distinct hawkish tone.
  • Financial markets responded with a sharp jump in the 2-year Treasury yield to 4.36%.
  • However, Warsh’s hands are tied by political considerations, and no rate hike is likely.

We are convinced that the FOMC will not hike rates at its September meeting despite the Fed Chair’s hawkish speech at Jackson Hole on Friday, August 28.

The new Fed Chair set a hawkish tone in his keynote address to the Fed’s Jackson Hole economic symposium in Wyoming.

“Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, ‌we have work to do. That’s our job … our mandate … and our charge to keep,” Warsh said.

….”The Fed’s predominant focus right now should be on prices.”

The 2-year Treasury yield jumped by 9 basis points within 20 minutes of Warsh’s speech and ended Friday up 13 basis points at 4.36%, more than 60 basis points above the Fed’s current target range of 3.5-3.75%.

2-Year Treasury Yield (CNBC)

However, Warsh is unlikely to support a rate hike before the November midterms because of the political implications.

Warsh has strong Republican credentials, having served in President George W. Bush’s White House and as the youngest board member in the Federal Reserve’s history. He has also spoken about the importance of free trade, the Fed’s political independence, and a strong Dollar — views that could lead to conflict with the current President. However, he has close links with Treasury Secretary Scott Bessent, having worked as partners at Stan Druckenmiller’s Duquesne Capital. He also has strong MAGA ties through his father-in-law, Ronald Lauder, son of Estee Lauder, who is a decades-long friend and ally of Donald Trump.

One of Warsh’s two appointees at the Fed is Paul Winfree, who authored the chapter on the Federal Reserve in the Project 2025 blueprint. The other is Daniel Heil, a fellow at Stanford’s conservative Hoover Institution, where Warsh served before joining the Fed.

Warsh enjoys the trust of President Trump, who regularly consults him on economic matters. A far stretch from the strained relationship with his predecessor, Jerome Powell, whom Trump did his best to undermine, including having him investigated by the Justice Department.

President Trump has a long history of turning on his political allies if they do not do his bidding. He repeatedly criticized his earlier appointee, Fed Chair Powell, for not lowering interest rates, going so far as to suggest that Powell was a bigger threat to the United States than Chinese President Xi Jinping. Powell insisted that the Fed made decisions based on data without regard to politics, but that did not seem to placate the President. The Fed then cut rates in September 2024, two months before the last presidential election, which seems to have convinced Trump that Powell was politically motivated.

We believe that Kevin Warsh is politically astute, having won nomination as Fed Chair despite his old-school Republican values. As a recent Trump appointee, presiding over a Fed that hikes rates two months before the upcoming midterm elections would likely be taken by the President as a betrayal of his trust. It would invite similar persecution to what his predecessor faced. That would be politically stupid.

Conclusion

The new Fed Chair is unlikely to convince President Trump of the need to hike rates ahead of the November midterm, and is unlikely to support such a move without his assent.

The President will not want to upset his predominantly blue-collar MAGA base, especially after the Iran debacle, when he needs a strong turnout in the November midterms. Your typical MAGA voter is not that sophisticated and is unlikely to be persuaded by arguments that higher interest rates will reduce inflation in 12 months’ time, but will instead be incensed by an increase in interest payments on their car loan and credit card.

This is kitchen table economics. That is what is driving Fed monetary policy.

Acknowledgments

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Australian CPI Sticky But No Rate Hike

Key Points

  • Australian CPI remains stubbornly high, with a 1.0% monthly increase in July.
  • Trimmed mean CPI was unchanged at 3.6% on a year-on-year basis.
  • However, the unemployment rate rose to 4.5% in July, suggesting the RBA is unlikely to raise rates.

Australian CPI remains stubbornly high, with the Trimmed Mean, the RBA’s favored measure, holding firm at 3.6% for the 12 months to July.

Australian CPI & Trimmed Mean CPI

Headline CPI eased to 3.5% for the 12 months, but that reflects base effects from the 1.3% increase in July last year compared to a jump of 1.0% in July 2026.

Australian CPI - Monthly & Annual

Strong CPI in July increases the motivation for another RBA rate hike, but Justin Smirk at Westpac points out that the labor market is softening.

Unemployment rose to 4.5% in July, up from 4.4% in June.

Australia: Unemployment

Monthly hours worked declined by 12.5 million hours in July to 1,998 million hours in seasonally adjusted terms, a monthly fall of 0.6%.

Australia: Aggregate Monthly Hours Worked

Conclusion

We agree with Westpac that the RBA is unlikely to raise rates:

Market services inflation is above target but a softer than expected labour market and wage outcomes reduce the likelihood of a November rate hike. We believe the RBA is likely to remain on hold for the remainder of this year.

However, credit is growing at an annual rate of 8.5% and broad money supply at 8.0%. Real GDP growth of 2.5% for the 12 months to March 2026 suggests that underlying inflation is between 5.5% and 6.0% (the spread between the two measures and growth in output/GDP).

Australia: Credit and Broad Money Growth

Our calculation of underlying inflation is more than 1.0% higher than the RBA’s current cash rate target of 4.35%.

We will likely be stuck with high inflation for a while.

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. ~ Milton Friedman

Acknowledgments

Notes

  1. Credit and money supply represent two sides of the same coin: bank lending and bank deposits. They only tend to diverge when the RBA injects liquidity to rescue the economy from a deflationary spiral, as in 2008, 2010-2013, and 2020.
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4 Key Takeaways for the Week

Key Points

  • Long-term Treasury yields climbed after the Fed kept rates unchanged.
  • The Japanese Yen is weakening as the Bank of Japan slow walks rate hikes.
  • Gold absorbs selling pressure as long-term rates rise.
  • China’s economy is slowing.

Treasury Market

The bond market has been anticipating a rate hike. This has been signaled since the 2-year Treasury yield broke above the Fed funds target range in March 2026.

2-Year Treasury Yield & Fed Funds Target (Upper Limit)

The FOMC voted to keep the Fed funds rate unchanged, with a target range of 3.5% to 3.75%. There were 3 dissenting votes, calling for a rate hike. The new Fed Chair, Kevin Warsh, is encouraging opposing views, and we can expect more dissent in the future. Warsh has also avoided forward guidance, which is likely to increase volatility in the bond market and consequently the term premium.

10-year Treasury yields climbed to 4.745% on Friday, reflecting market concern that the FOMC is not taking a more hawkish stance on inflation.

10-Year Treasury Yield

GDP grew at 6.5% over the 12 months to June, suggesting that the 10-year yield needs to rise by at least 175 basis points if the Fed is serious about containing inflation. Long-term interest rates below nominal GDP growth (the rate of return on new capital investment) encourage rapid credit growth, with demand expanding faster than output.

10-Year Treasury Yield & Nominal GDP Growth

Japan & the Sovereign Bond Market

Japan’s GDP grew by 3.6% over the 12 months to March 2026. The 10-year JGB yield is 2.8%, indicating that monetary policy remains stimulative, but less so than the US.

10-Year Treasury Yield & Nominal GDP Growth

The Bank of Japan kept its policy rate at 1.0% at last week’s meeting despite an upturn in CPI to 1.7%. The weakening Yen drives higher inflation.

Japanese CPI Inflation

The low BOJ policy rate and ongoing bond purchases aimed at suppressing long-term JGB yields undermine the currency. The Yen has steadily weakened, breaking above 160 against the Dollar in June 2026 to reach its highest level in 39 years. Japan’s Ministry of Finance intervened on Thursday to support the Yen, driving the exchange rate to 157 against the Dollar. However, the effect of these MoF interventions is short-lived because of BoJ policy.

Japanese Yen

Rising long-term yields in sovereign bond markets reflect growing concern over sovereign debt levels and the risk of fiscal dominance. When central bank policy is dominated by government bond markets’ need for support, with lower interest rates prioritized above containing inflation, the currency’s purchasing power is eroded, as in Japan.

The US 30-year Treasury yield has climbed to 5.275%, reflecting concerns over currency debasement.

30-Year Treasury Yield

The Japanese JGB yield is lower at 3.98%, but this reflects sizable ongoing QE by the Bank of Japan aimed at suppressing long-term rates.

30-Year JGB Yield

The Bank of Japan has higher debt levels relative to GDP than the UK and should theoretically trade at a higher yield. The difference in the 30-year Gilt yield lies in central bank monetary policy: the Bank of England is steadily shrinking its balance sheet, while the BoJ is actively buying JGBs in the secondary market to suppress yields.

30-Year UK Gilts Yield

Dollar & Gold

Rising short-term yields are strengthening the Dollar, with the 1-Year Treasury yield gaining more than 50 basis points in the last 6 months.

1-Year Treasury Yield (CNBC)

Gold has softened considerably from its peak of $5,500 per ounce and has been testing primary support at $4,000 over the past 8 weeks.

Spot Gold

Gold ETF inflows slowed in the first half of 2026 but remained positive, driven by continued inflows into Asian funds. North America experienced an outflow of $7.7 billion, European inflows slowed to $3.2 billion, while Asia recorded a strong inflow of $12 billion.

Gold ETF Flows

Average daily trading volumes surged to a record $488 billion in the first half of 2026.

Gold Average Daily Trading Volumes

OTC trading, led by the LBMA, averaged US$249bn/day, substantially above 2025 levels and underscoring the depth of institutional participation. Exchange-traded volumes also jumped, reaching US$227bn/day – 22% higher than the 2025 average – supported by elevated investor activity. Meanwhile, global Gold ETF trading averaged US$12bn/day – up 73% from 2025 – fueled primarily by robust trading in US funds as investors increasingly turned to Gold amid heightened macroeconomic and geopolitical uncertainty.

Comex futures net longs increased to 538 tonnes, up 16% since May, and the highest month-end level since January despite a weakening gold price. A closer look shows retail participation (non-reportable net longs declined in June, while other reportables, which capture large trades outside the managed money category, were up 16% from May. Managed money net longs remained broadly stable, declining by just 43 tonnes year-to-date. Again, H1 investor behavior differed: retail positioning largely tracked short-term price movements while larger traders’ positions have, in general, stayed stable since mid-March. (WGC)

Comex contracts standing for delivery jumped to 13,123 in July from 8,838 in May, and a 9.0% increase over July last year.

Spot Gold

China

The Chinese NBS Manufacturing PMI fell to 49.2 in July, down sharply from 50.3 in June. Values below 50 indicate a contraction in the manufacturing sector.

China: NBS Manufacturing PMI

The OECD Composite Leading Indicator for China fell to 98.6 in June, below its long-term average of 100, signaling a contraction.

OECD: China Composite Leading Indicator

The RBA’s activity indicators for China show industrial production is holding up, boosted by record exports. However, real retail sales growth has stalled, while fixed asset investment has contracted sharply following Trump’s tariff blitz last year.

OECD: China Activity Indicators

Household credit growth (purple below) has also stalled. Business credit has taken up the slack, but government credit growth is also contracting.

OECD: China Total Social Financing

Conclusion

10-year US Treasury yields jumped to 4.745% after the Fed kept its funds target range at 3.5%-3.75%, reflecting bond market concerns over inflation.

The new Fed Chair’s strategy is to keep short-term rates low and allow long-term rates to rise, to slow the rate of demand growth in the economy and curb inflation. However, nominal GDP is growing at an annual rate of 6.5%, which means that 10-year Treasury yields would need to rise by 175 basis points to keep inflation in check. An increase to 6.5% would likely cause a sharp contraction in stocks.

Japan’s Ministry of Finance has intervened to support the Yen. However, the effects will likely be short-lived, as the Bank of Japan continues to maintain stimulative monetary policy, which fuels inflation and undermines the currency.

Rising long-term sovereign debt yields reflect bond market concerns over rising sovereign debt and the risk of fiscal dominance, as in Japan, where the central bank has prioritized maintaining an orderly bond market above price stability. Erosion of the currency purchasing power is the inevitable outcome.

Gold has found strong support at $4,000 per ounce, with long-term investors prepared to wait out the turmoil in the Middle East. Demand from Asian investors has been particularly strong, but could be undermined if China goes into recession.

China’s economy shows increasing signs of contraction, precipitated by a decline in business investment following President Trump’s 2025 tariff attack. Household credit and real retail sales have stalled, and the NBS Manufacturing PMI fell to 49.2, signaling a contraction. Higher fuel prices would be an added headwind that could tip the economy into recession.

Acknowledgments

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