Global markets await interest decisions from the Federal Reserve and the Bank of Japan with the rise in oil and Gulf tensions

The dollar rose in Asian trading on Monday, while the yen maintained its gains near its highest level in seven months, as investors awaited interest rate decisions from the Federal Reserve and the Bank of Japan later this week, while rising oil prices and escalating tensions in the Gulf increased pressure on the markets.

Global markets are dealing with volatile price pressures resulting from the US-Israeli war on Iran that has been ongoing for six months, which pushed oil prices to exceed $100 per barrel and confused the path of interest rates, coinciding with a wave of selling in long-term bonds.

The European Central Bank kept interest rates unchanged last week, while warning of the possibility of the need for further hikes, thus paving the way for the Federal Reserve’s decision on Wednesday, and the widely expected hike by the Bank of Japan on Friday.

Traders raised their bets on the Federal Reserve raising interest rates after data released on Friday showed an acceleration in American consumer prices in August. Markets are currently pricing in an 86 percent chance of a rate hike this week, with another move expected later in the year, according to the CME Group's Fed Watch tool.

Shane Oliver, chief economist and head of investment strategy at AMP, said that delaying the Fed’s rate hike may be difficult, especially since its meeting in October precedes the US midterm elections, while waiting until December may be too late.

The euro fell 0.1 percent to $1.1585, while the British pound recorded $1.3516. The dollar index, which measures the performance of the US currency against six major currencies, rose 0.12 percent to 99.22 points, after recording limited declines over the past two weeks.

US Treasury bond yields maintained high levels near their highest levels in several years, while two-year bond yields, the most sensitive to interest rate expectations, fell slightly to 4.6148 percent, after rising 26 basis points last week.

Rising yields and shifting interest rate expectations have not yet led to clear support for the dollar, as major central banks in other economies are also preparing to raise interest rates, at a time when the prospects for US monetary policy are still uncertain.

Analysts at the Commonwealth Bank of Australia said that Federal Reserve Chairman Kevin Warsh will need to translate his tough tone into actual monetary policy measures, otherwise he may face additional risks in the bank’s efforts to control inflation.

They added that there is a limited possibility for the dollar to decline if the Federal Reserve raises interest rates, but during his press conference, Warsh reduced the possibility of implementing additional increases.

In the oil market, Brent crude futures rose 3 percent to $107.60 per barrel, after new Houthi attacks on Saudi Arabia and Iranian attacks on ships in the Gulf.

Yen faces Bank of Japan test

The yen fell 0.3 percent to 154.03 against the dollar, but remained close to the seven-month high of 152.89 yen recorded last week.

There are signs of a shift in investors' positions towards the Japanese currency, as speculators have begun to form net buying positions on the yen for the first time since February.

MUFG analysts said in a note that the 25 basis point rate hike has become largely priced in in the markets, adding that strengthening the yen further will require a signal from the Bank of Japan of its intention to maintain a faster pace of rate hikes.

TD Securities said that the lack of a rate hike at the Bank of Japan meeting may push the dollar against the yen to rise again towards levels ranging between 157 and 160 yen, if the bank focuses on the possibility of raising rates in the October or December meetings.

The yen has risen by about 4 percent since the beginning of September, supported by expectations that the Bank of Japan will accelerate the pace of raising interest, in addition to indications that local investors may increase their holdings of yen-denominated assets.

James Adley, fixed income portfolio manager at Marlboro, said that not raising interest rates would be a “catastrophic mistake,” stressing the importance of the bank sending strong and clear messages about the course of monetary policy.

Asian stock markets fell on Monday, under pressure from shares of artificial intelligence companies, at a time when escalating concerns about energy supplies in the Middle East led to a rise in oil prices again. While investors are preparing for a possible hike in interest rates in the United States and Japan this week.

Shares of companies related to artificial intelligence fell after the presidents of OpenAI and Anthropic called for slowing the pace of technology development in order to manage risks and protect humanity.

In the oil market, Brent crude rose by about 3 percent, with tensions escalating after new attacks on Saudi Arabia and ships in the Gulf, which followed an attack on a Saudi oil pipeline, which raised fears of expanding global energy supply disruptions.

A meeting was scheduled to be held in Oman on Monday between Iran and Arab Gulf states to discuss an agreement on reopening the Strait of Hormuz, but the meeting was postponed.

With navigation traffic in the Straits of Hormuz and Bab al-Mandab at risk, analysts fear that oil prices will remain high for a long time, which may increase inflationary pressures on the global economy.

In the United States, higher than comforting consumer price data on Friday prompted markets to price in an 86 percent chance of the Federal Reserve raising interest rates by 25 basis points on Wednesday, with another hike expected by December. This will be the first US interest rate hike since mid-2023.

Michael Feroli, chief American economist at JP Morgan, said that the bank now expects the Federal Reserve to raise interest rates twice this year, in September and December, adding that failure to translate statements into actions may jeopardize the credibility of the central bank.

He explained that whether these steps would constitute a limited re-adjustment of monetary policy or the beginning of a more sustainable cycle of raising interest would depend on the upcoming data, indicating that the bank favored the first scenario, with risks towards the second.

Brent crude futures rose 2.6 percent to $107.36 a barrel, after recording gains of nearly 9 percent last week, while West Texas Intermediate crude rose 2.4 percent to $102.48.

Japan's Nikkei index fell 0.8 percent, while South Korean stocks fell 2.1 percent after calls to slow down the development of artificial intelligence. The broader MSCI index of Asia-Pacific stocks excluding Japan fell 0.8 percent, while major Chinese stocks fell 0.4 percent.

In Europe, Euro Stoxx 50 futures fell 0.2 percent, German DAX futures fell 0.1 percent, while British Financial Times futures rose 0.2 percent. On Wall Street, Standard & Poor's 500 futures fell 0.4 percent, while Nasdaq futures fell 1.1 percent.

Bond yields test stock valuations

US 10-year Treasury bond yields stabilized at 4.974 percent, nachdem Bonds have been subjected to strong selling in recent weeks. During the past week alone, the two-year bond yield rose 26 basis points, while the 10-year bond yield increased 19 basis points, flattening the yield curve.

Ben Snyder, chief US equity strategist at Goldman Sachs, said that strong corporate profits could provide support for US stocks if borrowing costs rise.

He added that stocks usually face difficulties when the Federal Reserve starts raising interest rates, but the bank expects the bull market to continue. He pointed out that the Standard & Poor's 500 index recorded an average decline of 2 percent during the first three months of seven interest-raising cycles in the past decades, but in contrast, it achieved an average return of 9 percent during the 12 months following the first interest hike.

In Japan, markets are pricing in a probability of about 76 percent that the Bank of Japan will raise its key interest rate by a quarter of a percentage point to 1.25 percent during its meeting on Friday.

The Bank of Japan is also expected to adopt a tough tone regarding further rate hikes, as it attempts to prevent the yen from falling again, after intervention in the exchange market helped keep it away from its lowest level in 40 years.

The dollar rose slightly to 153.98 yen, after falling about 4 percent over the past two weeks, moving away from the July peak of 163.99 yen. The euro fell marginally to $1.1586, after finding support at $1.1570 on Friday.

The pound sterling settled at $1.3513, while the Bank of England is expected to keep interest rates at 3.75 percent on Thursday, with the possibility of a split vote again.

In metal markets, gold settled at about $4,347 per ounce, as rising bond yields reduced the attractiveness of the non-yielding metal.

Goldman Sachs and JP Morgan have joined a growing list of institutions that expect the US Federal Reserve to raise interest rates this week, after a series of inflation data showed stronger than expected, raising doubts about the continued decline in price pressures without additional tightening of monetary policy.

The new forecasts come after data released last week showed that consumer and producer prices in the United States rose more than expected during August, coinciding with the rise in oil prices to more than $100 per barrel, amid escalating tensions in the Middle East.

In a note issued on Friday, Goldman Sachs abandoned its previous expectations to keep the interest rate unchanged, and now expects it to be raised by 25 basis points during the Federal Reserve meeting scheduled for September 15 and 16.

JP Morgan also expects to raise interest rates by 25 basis points in September, followed by another hike in December.

Recent inflation data revived fears that progress towards the Fed's 2 percent target may falter, after months of slowing price pressures.

David Merkel, chief economist at Goldman Sachs, said that the bank believes that the Federal Open Market Committee “will hesitate to cause a surprise” during the meeting.

JP Morgan, in turn, took a more stringent tone after the release of inflation data. Economists at the bank, led by Michael Feroli, said that rising bond yields and energy prices, along with a series of higher-than-expected inflation readings, made a rate hike at the next Federal Committee meeting more likely.

The prospects for tightening US monetary policy will be the focus this week, with the Federal Reserve concluding its meeting on Wednesday, while markets are also awaiting monetary policy signals from the Bank of Japan.

JP Morgan said that the inflation data raised doubts about the sustainability of the inflation slowdown, which led it to expect another US interest rate hike this year, and it also raised its estimate of the long-term interest rate level to 3.25 percent.

Markets are currently pricing in a probability of about 87 percent to raise US interest rates by a quarter of a percentage point this month, up from 70 percent before the release of the latest inflation data, according to the CME Group’s Fed Watch tool. Markets also expect another hike in December.

In a separate note on Sunday, Goldman Sachs said that it still expects two rate cuts in 2027, although they are likely to occur later than previously expected, as it believes that the expected hike this week will be driven more by inflation fears than by economic fundamentals.