AI Spend, Oil Weigh on Prices

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 lower overnight as traders investors digested big tech earnings that have seemingly rekindled worries over heavy AI spending, while the recent rise in oil lifts Fed rate hike odds and weighs on risk appetite. Alphabet and Tesla, the first of the “Magnificent Seven” to report, both underwhelmed the market despite headline growth metrics. Alphabet delivered its strongest‑ever quarter for cloud growth, but the focus quickly shifted to higher spending plans, and the stock is down pre‑market. Tesla shares are off roughly 6% after it posted negative free cash flow for the first time in more than two years, underscoring how its big bets on AI/autonomy and new products are not yet translating into clear financial returns. However, these two companies are at different stages of the investment cycle, with Alphabet beginning to show early returns on AI spending, while Tesla still has room to run in terms of results. 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 attention is shifting from the Strait of Hormuz to the Red Sea: Iranian‑aligned Houthis near Bab el‑Mandeb have opened a new front in the conflict, increasing  risk to global energy and trade routes beyond the Gulf. Brent has climbed to about $99bbl, its highest level since early June, reviving inflation concerns and pushing 2‑year Treasury yields to a 17‑month high as markets add to Fed‑hike pricing.

CURRENCIES

US DOLLAR: The USD index moved higher overnight to 101.35, with the dollar hitting a 40-year high against the yen. The divergence between US and European yields continues to play a dominant role in price direction for the dollar and euro alike. While European Central Bank tightening expectations are greater than those of the Fed, safe‑haven support from US strikes on Iran and renewed threats to shipping are likely to offer the dollar an edge. Meanwhile, a strong Q2 earnings season will help offer some support.

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 fell 0.29% to $1.1378. The ECB left policy rates unchanged today but kept a September hike firmly in play, as a fresh energy shock from renewed US–Iran hostilities has pushed euro-area gas prices toward three year highs. While recent data on wages, services inflation, activity and expectations have been relatively benign, with little evidence so far of second‑round effects and a softer labor backdrop, particularly in Germany, markets are now pricing almost three further hikes by early next year, largely on the back of energy rather than growth fundamentals. With headline inflation expected to hover near 3% and risks from hot summer weather and food prices still present, Lagarde is likely to stress that the Governing Council remains ready to tighten again if the energy shock begins to spill over more forcefully into wages and broader prices, even as she tries not to validate the full extent of market pricing.

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 0.25% weaker at $1.3341. 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. Prime Minister Burnham said he would lower business rates for by 20% for certain venues from April, his third announcement of measures to help businesses. Chancellor Healey said he would maintain budget discipline. The bigger swing factor is oil: Brent has jumped more than 4% to near six‑week highs as Middle East shipping risks intensify. With a fragile geopolitical backdrop, the pound remains vulnerable to a pullback toward $1.32.

JAPANESE YEN: The yen fell 0.34% to 163.68 yen per dollar, a 40-year low. 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 0.27% lower 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 higher in a flattening move, with the 10-year yield rising to 4.70%. With the US and Iran signaling that a resumption of peace talks is unlikely in the near-term and with new risk added regarding the Houthi’s in Yemen, the path of least resistance appears higher. 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. Iran, the US and Israel are largely conditioned by oil prices and as prices approach $100, escalation could give way to de-escalation.

Policymakers at the Fed are in their pre-meeting blackout period. The Fed is expected to leave the fed funds rate unchanged. However, markets continue to price in the possibility of policy tightening later this year, with traders assigning roughly a 83% probability of 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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