Weekly Market Review

Warsh walks the walk

As the Danish proverb goes ‘It’s hard to make predictions, especially when they’re about the future’ – this is one of the reasons why Fed Chairman Kevin Warsh refrains from providing forward guidance on future interest rate policy decisions.

The other is that reading the market is an important aspect of the conduct of monetary policy, and to influence the market through the provision of guidance obscures the very signals they are trying to read. This has not been a challenge in recent weeks; the market has demanded this rate hike and if the Fed had not delivered the weakness across the US bond market would have become even more acute.

Since taking the helm at the Fed Warsh had talked tough but done little and investors were beginning to question the Fed’s credibility in the deliverance of price stability. The bond market demanded action and the Fed delivered with a unanimous 12-0 vote.

In our view, Warsh is fundamentally a price stability pragmatist and questions over his credibility are unfounded. His commitment to price stability is sincere and this hike is necessary. During the press conference, Warsh said he would be "hard pressed to describe financial conditions as restrictive", signalling that further rate rises remain possible. While Warsh may not be in the forward guidance business, his reaction function here is clear, in making these statements he leaves open the door for further interest rate increases. The FOMC concur with the dot plot showing eight members expecting a second hike this year and a third in 2027 while four see a further two hikes this year. The median expectation across the FOMC is for one further hike this year and none in 2027 – on this basis the Fed remains behind the market which has a more hawkish expectation.

On inflation we have held the view for some time that pressures are primarily coming from two areas: energy and AI. In this regard there is no better argument than August’s data on import prices. Import prices rose 7.0% year-on-year in August, the fastest pace since August 2022. Petroleum import prices rose 27.3%. Import prices from the newly industrialised Asian countries surged 12.6%, consistent with the intense demand we are seeing for the semiconductors, servers, memory and other electronics required for the AI build-out. The AI build out continues to put upward pressure on prices – this is likely to continue until AI adoption produces enough productivity enhancements to offset the demand/supply imbalance – while this could happen, like a leprechaun's gold, such productivity gains seem to be getting further away the closer we get.

United States

US markets have shown notable resilience following the Federal Reserve’s first rate increase in more than three years. After an initially cautious response to the 25 basis point hike, equities recovered as investors balanced the prospect of further tightening against continued strength in corporate earnings and the US economy. The Nasdaq reached a record closing high on Monday as enthusiasm around artificial intelligence returned, while the S&P 500 also advanced strongly. At the same time, the bond market remains an important constraint: the 10-year Treasury yield has traded around the 5% level and markets continue to price a meaningful possibility of another rate increase before year-end. The recent retreat in oil prices has provided some relief by reducing immediate inflation concerns, but the Federal Reserve has made clear that price stability remains its priority. For investors, this creates a more selective environment in which earnings delivery matters increasingly. The encouraging feature is that US companies continue to demonstrate an ability to grow profits despite higher financing costs, while investment in technology, infrastructure and productivity remains substantial. This combination should continue to provide opportunities, although higher interest rates mean valuations and the quality of earnings will remain under greater scrutiny.

Europe

European markets have also responded positively to some easing in energy prices, with the STOXX 600 recording its strongest daily gain since July at the start of this week as technology and banking shares advanced. Europe nevertheless faces a complicated backdrop. The region remains particularly sensitive to energy costs, while government finances and political uncertainty in some of its largest economies have pushed sovereign bond markets back into focus. France’s fiscal position remains a concern for investors and the spread between French and German government borrowing costs has widened, while Germany is navigating both political uncertainty and a changing economic model. Against this, European companies offer meaningful exposure to global industrial activity, financial services, healthcare, technology and infrastructure, and valuations in many areas remain less demanding than in the US. The decline in oil prices from recent highs is particularly helpful for Europe because lower imported energy costs would ease pressure on households, companies and inflation. With the European investment cycle increasingly focused on defence, infrastructure, energy security and productivity, the region continues to offer a broad set of opportunities for long-term investors, even as near-term political and fiscal risks require careful selection.

Global Markets

Global markets begin the week with a somewhat improved tone as lower oil prices and retreating long-dated bond yields provide relief after a period of considerable macroeconomic pressure. The central-bank cycle has clearly shifted, with the Federal Reserve and Bank of Japan raising rates and the Bank of England adopting a more hawkish stance, but markets have so far absorbed this tightening without a significant deterioration in global risk appetite. Artificial intelligence remains an important driver of earnings expectations and capital expenditure, with renewed strength in semiconductor shares demonstrating that investors still see substantial long-term potential despite recent concerns around safety, valuations and the scale of investment required. Geopolitical risks remain elevated, particularly in the Middle East and Ukraine, and these can quickly affect energy prices, inflation expectations and market sentiment. At the same time, potential diplomatic progress between the US and Iran, alongside upcoming US-China discussions, provides a reminder that geopolitical developments can move in both directions. The broader investment opportunity set remains diverse across the US, Europe, Asia and emerging markets, reinforcing the value of portfolios that combine different regions and asset classes rather than relying on a single source of return.