Market Flash: US policy makers are caught in a dilemma

Geopolitical supply risks and fiscal uncertainty are pushing up commodities and long-term bond yields, but the authors retain a constructive view on equities and credit while remaining bearish on the US dollar.

• Oil flows through the Strait of Hormuz are estimated at about 5 million barrels a day rather than the 10 million claimed by the US administration, while Houthi attacks have slowed Saudi exports and constrained refined-product supply.
• European gas prices, a hot summer, low French nuclear output and the risk of a strong 2027 El Niño helped lift the global commodities index above its 2022 peak; the US budget deficit remains around 6% despite economic growth.
• The Treasury plans to increase buybacks of 10-, 20- and 30-year bonds from $2bn to at least $4bn, briefly supporting markets but weakening the dollar and lifting precious metals; the risk of losing Senate control before the midterms is estimated at 51%.
• US equities fell 1.9% for the S&P 500, 2.8% for the Nasdaq 100 and 2.5% for the Russell 2000, while WTI rose 6.6%; technology dropped 3.2% and the SOX semiconductor index fell more than 5% amid AI funding concerns.
• European second-quarter earnings were up 23% year on year, or 12% excluding energy, while China’s July industrial production slowed to 4.5% and retail sales grew only 0.6%; South Korean first-20-day exports rose 56%, driven by a 198.8% surge in chip shipments.
• Credit markets remained resilient despite higher government yields: the Xover widened 6bp, cash index spreads only 1bp, and German Bund yields rose from 3.20% to 3.26%; investment-grade and high-yield bonds nevertheless finished lower.

Takeaway: The authors expect short-term geopolitical and fiscal volatility to persist, so they have added hedges, but they still favour equities, investment-grade and high-yield credit because AI-driven productivity gains and resilient earnings could support markets; they remain negative on the US dollar.