Fed Rate Hike Odds Rise

MACRO FRAME

The military exchanges between the US and Iran re-inflate the geopolitical risk premium in energy and add a hawkish skew to the macro backdrop.

STOCK INDEX FUTURES

Equity index futures were modestly higher overnight as investors digested new tariffs, and another oil-driven rise in Fed hike odds following yesterday’s tech-lead losses. On the earnings front, Intel added to the earnings slate with Q2 profit and revenue guidance above Wall Street expectations and plans to increase capex over the next two years; the stock is up about 3–4% pre-market. Still, the broader semiconductor index remains as a point of volatility amid concerns that the AI trade has run ahead of tangible returns. Results from Alphabet and Tesla underscore that the AI-capex reaction function is driven by two factors. 1: demand for visible returns and free cash flow discipline. Investors are increasingly insisting that massive AI capex be matched by clear revenue and profit growth, not just “technology promise.” 2: skepticism about overinvestment and valuation risk. This skepticism shows up as rotation away from the most crowded, high‑valuation AI plays and a focus on differentiating winners (where capex is likely to earn high returns) from losers (where spending may be excessive or mistimed). AI spending plans are likely to remain under the microscope and determine at-large sentiment for tech as investors assess whether AI infrastructure is producing meaningful returns, and whether profit growth can or will justify elevated valuations.

Geopolitical risk remains in balance for markets, Brent retreated slightly after testing the $100 level once again on Thursday. The US continues to strike targets in Iran, while President Trump threatened “major military punishment” for Tehran and its Houthi allies in Yemen for bringing the war to the Red Sea. Elsewhere, the Trump administration replaced its expiring 10% global tariff with new 10–12.5% duties on goods from around 60 trading partners, including Europe and China, citing lax enforcement of forced-labor bans. These replacement tariffs were widely anticipated, are lower than the initial global levy, and include carve-outs designed to blunt the immediate impact on consumer prices, making them more of a “business as usual” backdrop than a shock event for markets.

CURRENCIES

US DOLLAR: The USD index was little changed at 101.45. The sustained move above the 100 level since mid-June continues to reflect market expectations that the Fed will hike rates later in the year, leaving price direction vulnerable to the divergence in expectations between Fed and ECB rate expectations. Meanwhile, elevated safe‑haven support from US strikes on Iran and renewed threats to shipping are likely to offer the dollar an edge alongside a decent tailwind from a strong Q2 earnings season. Today’s ISM data will hold the next move for the dollar, which is likely to find support if the reading continues to point to robust price pressures.

Watch point: June’s inflation data is bearish for the dollar, though the report’s impact may be partially overshadowed by the current geopolitical backdrop and the rise in oil prices.

EURO: The euro is little changed at $1.1370. The ECB left its deposit rate at 2.25% as expected, but Lagarde made clear that renewed energy shocks have made a September hike more likely. Lagarde warned that the “full effects of the energy shock have yet to play out” and that earlier hopes of a benign scenario were unlikely. While recent data on wages, activity and expectations have shown little evidence of second‑round effects, services inflation even eased and firms report muted pay pressures, euro‑area gas prices are at three‑year highs leading markets to now price two hikes by February 2027, with swaps fully discounting at least one increase by October. Lagarde’s messaging keeps that option firmly on the table while acknowledging that soft labor markets, structural industrial headwinds, and weather‑related food and shipping risks all complicate the inflation outlook.

Watch point: With the MOU seemingly done with, policy expectations are biased upwards though performance of EUR remains dependent on US inflation data and domestic growth factors.

BRITISH POUND: Sterling is little changed at $1.3309. The pound remains caught between competing forces: rate hike expectations and questions surrounding the strength of the economy. While fiscal uncertainty has is still present for markets amid the new government, it has largely been priced in for sometime and finance minister Healey has been a reassuring choice for gilt markets. Just like the ECB, the Bank of England is expected to keep rates on hold at its meeting next week. Still, traders remain fully priced for a hike come November. UK inflation data for June came in softer than expected, helped by a brief drop in fuel prices, though the result had largely been anticipated, so rate expectations were little changed.

JAPANESE YEN: The yen is unchanged at 163.86 yen per dollar. Verbal efforts to support the yen have had little effect on the currency, and official intervention is unlikely to offer a durable rebound unless the Bank of Japan commits to raising rates quickly. Therefore, BOJ rate hike expectations will continue to be the dominant driver in yen direction, outside of the geopolitical bid. Economists in the latest Reuters poll see the BOJ delivering another 25bp hike by year‑end, most likely in December, with some risk of an earlier move in October. The central bank remains caught between a weak yen and higher oil, which are expected to push core inflation into the mid‑2% range by the fourth quarter, and worries that faster tightening could amplify debt‑servicing costs and hamper a still‑fragile recovery. With dollar/yen hovering in territory many view as too weak relative to fundamentals and JGB yields at multi‑decade highs, the consensus favors a gradual path toward a terminal rate near 1.5%, while the government’s recent reaffirmation of BOJ independence is intended to calm earlier jitters about political pressure to keep rates low. Still, Prime Minister Takaichi’s government has retained language in its economic blueprint urging the BOJ to align with government policy, fueling worries that Tokyo might pressure the bank to slow further hikes.

Watch point: With the yen sustaining a break above the 160 level, intervention from the government appears to be the greatest near-term risk against further depreciation.

AUSTRALIAN DOLLAR: The Aussie is 0.10% higher at $0.6975. Strong jobs data has added to expectations that the Reserve Bank of Australia will raise rates again before year-end. The Australian Bureau of Statistics showed net employment rose 76,300 in June from May, above forecasts of a 15,300 gain and moving the annual pace of job gains to 1.7% from 1%. The unemployment rate remained steady at 4.4%. Now, the RBA’s key concern is whether or not strong job gains turn into wage growth demands. Price pressure in the economy remain uncomfortably high, especially with crude up 26% this month. Traders are now fully priced for a rate hike by year-end.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to be in focus in upcoming data.

TREASURY FUTURES

Yields moved lower across the curve, the 10-year yield retreated from 4.70%, which it hit yesterday. As long as oil prices trade withing the $70-$90 range, a resumption of peace talks appears unlikely. With oil now about that level, the theory that escalation could lead to deescalation is set to be tested as both Iran and the US remain conditioned by oil prices. Oil inventories in the US and elsewhere are at their lowest in decade, which would add incentive for the US to negotiate the start of flow of oil through the strait again. Policymakers at the Fed are in their pre-meeting blackout period. The Fed is expected to leave the fed funds rate unchanged. However, traders are now fully priced for a rate hike at the September meeting. A stable labor market has also supported the view that policymakers are expected to focus on taming inflation. A Reuters poll showed that economists are expecting the Fed to keep rates on hold for the remainder of the year, while a majority of those who answered a separate question about the chance of a rate hike this year now described the likelihood as “high”, a reversal from last month when most saw it as “low.”

Watch point: Mainly, the renewed fighting and prospect that some inflation remain sticky reinforce a hawkish backdrop for the Fed despite a drop in the headline reading.

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