Ballroom Blitz

US inflation is the key catalyst for the next Fed decision, while bond-market losses should become self-limiting and UK rate expectations look too aggressive.

• Ten-year Treasury yields near 5% are more than 1 percentage point above the S&P 500 trailing earnings yield, making bonds relatively more attractive and potentially capping the equity selloff.
• August US headline CPI is expected to rise 0.4% month over month from 0.1% in July and remain at 3.4% year over year; core CPI is forecast at 0.2% month over month and 2.4% year over year, down from 2.5%.
• Markets price a 68% probability of a 25-basis-point Fed hike to 3.75%-4.00% on September 16; a hot CPI would support the hike and the dollar, while a cooler reading would revive the case for a hold.
• UK real GDP grew 0.4% month over month in July, beating the 0.0% consensus, but the negative output gap, restrictive policy rate and tighter fiscal outlook argue against the swaps curve pricing 100 basis points of Bank of England hikes over twelve months.
• The ECB raised its policy rate by 25 basis points to 2.50% and signaled further hikes, while higher inflation projections for 2027 and 2028 and stronger growth projections for 2026 and 2027 support the euro relative to the dollar.

Takeaway: Investors should prepare for an unusually volatile reaction to US CPI, but the author expects Treasury yields to limit the bond rout, the dollar to remain vulnerable to dovish repricing despite a possible Fed hike, sterling to weaken if BoE expectations are reduced, and euro-dollar rate differentials to remain supportive of the euro.