Weekly Market Recap

Energy remains the fulcrum on which the markets swing.

Brent crude oil drifted lower, offering markets some welcome relief, before bouncing back with a vengeance, more than 7% in two days and taking the shine off equities with it.

Last Friday brought better news: the energy complex softened again, with Brent crude briefly dipping below USD105 per barrel on reports that U.S. and Iranian intermediaries are exploring a phased reopening of the Strait of Hormuz.

Even with Iranian President Masoud Pezeshkian having been in New York, and talks with Iranian envoys having taken place, there was plenty to be sceptical about. The Iranian negotiating position looked little changed from the memorandum that collapsed within weeks of being signed in June. Sure enough, President Trump rejected the deal, claiming Iran had overplayed its hand.

But with five weeks to go until the U.S. mid-term elections, easing gasoline prices could easily be the factor that allows the Republicans to retain the Senate, and this will form part of the calculus for Iran. After the mid-terms, a crucial source of leverage will have passed.

Diesel’s choke point

Diesel is becoming a major choke point due to the blockage of the Strait of Hormuz and Ukraine’s strikes on Russia’s refineries.

As ever, Europe is collateral damage and Mark Rutte, secretary general of NATO, pointed out that the continent has too little capacity in the event of a disruption to global supplies. It is an awkward position as funding new refineries in case of conflict makes little sense during peacetime, and when demand is in structural decline due to the increase in EV (electric vehicle) usage.

Natural gas offers a more benign picture. European prices have fallen more than 10% from their recent high, helped both by the de-escalation chatter and by early forecasts pointing to a mild, wet winter. However, as the season starts with low storage, a January cold snap would bite harder than usual.

Oil above USD100 per barrel benefits oil producers but increases inflation, which in turn increases interest rates, creating a headwind for most other assets. Government bond yields now sit at levels not seen since around the global financial crisis, with the five-year U.S. Treasury above 5% for the first time since 2007 and the 30-year back to levels last seen in 2004.

Expensive oil transmits into equities along three channels: higher discount rates compress valuations, higher financing costs squeeze leveraged borrowers, and property and lower bond prices suck liquidity out of markets, making them susceptible to volatility.

The distinction that decides how this ends is whether yields are rising because growth is strong or because inflation is feared. Shares can climb through rising yields when the cause is a healthy economy; they struggle when the story turns to central banks having to tighten further.

Some like it hot

The U.S. economy is running hot. The flash composite Purchasing Managers’ Index reached 58.4 this month, up from 56.0 in August. Outside the post-lockdown reopening burst, that is the quickest pace of expansion recorded since 2015, with manufacturing and services both firing. The catch sits in the cost column.

Firms’ input costs jumped at the steepest rate in four years and the surveyors pinned that squarely on fuel and transport costs rising with oil.

Higher energy prices act like a tax, taking money out of everyone’s pockets. Whether that proves inflationary or demand-sapping depends on the labour market. There, the news was also firm, with services employment building on an earlier bounce in jobs growth.

Consumer sentiment bounced back

Europe is quietly improving too. The eurozone composite hit a 41-month high of 53.1, with France and Germany both in expansion for the first time since November 2025 a better story than the single U.S. reading suggests. 

However, the same energy-driven price pressure came through in the data, which strengthens the case for another European Central Bank rise before year-end.

The UK drew the short straw. Activity slipped to a three-month low while input costs accelerated, a more stagflationary mix than either the U.S. or the continent. August borrowing of £18.3billion came in above forecast, with debt interest at its heaviest for an August since 1997.

The UK economy looks more exposed than most if energy costs stay elevated approaching the Autumn Budget on 28 October.

Consumer confidence had rebounded, aided by the new prime minister’s more upbeat tone. He has retained that and expressed his reluctance to raise taxes, but a fiscal noose is tightening, driven by factors outside Britain’s control.

The arithmetic of pain

Debt interest is the thread that runs from here into the longer term.

Oaktree’s Howard Marks discussed America’s situation in his latest influential memo. His prescription is conventional: raise government revenues largely through higher taxes on the wealthy and restrain the growth in spending.

However, that doesn’t seem likely as legislation already on the books pushes spending growth higher over time, and no one wins an election promising austerity.

The path of least resistance

History suggests a different route. Japan reduced its debt burden not through spending cuts or tax rises but by holding interest rates below the rate of nominal growth (before inflation). 

That is the path we’d expect the U.S., and probably others, to take as debt service costs climb: policy rates set below inflation to avoid choking off growth, banks nudged into holding government bonds, and the term premium (extra yield for longer-dated bonds) managed down if long yields creep up.

The risk is that inflation ends up running well above rates rather than a little above, at which point the tools get blunter still. 

It is worth remembering that earning a real return (above inflation) on cash is not the natural order of things for most of the past century, savers have been fortunate simply to preserve spending power, and tax has usually settled the argument.

If cash cannot be relied on to protect purchasing power, the answer is to own real assets. Carefully selected equities can form a meaningful part of that, alongside contractual claims on inflation, such as index-linked bonds. This makes the question of whose earnings are genuinely durable the important one, and the market answered it rather hastily.

What’s coming up?

Gainfully employed: 

100,000 new U.S. jobs are expected to have been created in September. This Friday brings the first official estimate alongside more reliable labour market data.

A little more conversation: 

The Labour Party conference begins weeks before the new government announces its first budget.

Rise of the robots: 

Will AI extend its run as the leading cause of job losses as employment enjoys a renaissance?

As in previous weeks, the juxtaposition of the AI boom and fallout from the conflict between the U.S. and Iran remains centre stage.

A major development on the AI front came from Anthropic’s CEO, Dario Amodei, who released an essay entitled “We must pace the Frontier”. In it, he argued that AI development has reached a critical inflection point requiring deliberate slowing, not halting, of advancement to let safety measures catch up.

His stated motivation rested on two concerns: the rapid acceleration of “recursive self-improvement” (AI building better AI), and the incident in which AI agents at OpenAI displayed swarm-like unauthorised cyberattacks and attempts to hack their own evaluation systems, resulting in the hacking of Hugging Face (a hub for open-source AI models, datasets, and machine learning tools). Amodei proposes:

• unilaterally embedding third-party evaluators at Anthropic to verify safety practices
• coordinating with other democratic AI companies on shared safety standards
• pursuing global cooperation, even with authoritarian rivals like China, through a tiered framework ranging from banning clearly dangerous uses to eventually agreeing on ‘speed limits’ for AI self-improvement.

Sam Altman (of OpenAI) and Elon Musk (of SpaceX, xAI) voiced their agreement. Agreement between rivals always provokes scepticism, in this case, suspicions of an attempt at regulatory capture.

The idea is that frontier models have been engaged in an arms race of development in the hope of gaining an unassailable lead in AI capability, with mixed success so far. Frontier model capabilities have advanced meaningfully but, as we have discussed in recent weeks, the open-weight models (models with freely available weights) remain close behind. These offer lower costs, smaller models and more transparency and security, while also consuming less capital themselves.

We have characterised this market as a prisoner’s dilemma before. If any single firm outpaces its peers’ spending, it could monopolise the frontier. But if a number of firms compete, the frontier will become commoditised and competitive. Better for all would be to slow development, save costs and turn attention to fighting off the chasing pack.

That would mean creating a barrier to entry in the form of regulatory requirements that would be difficult for challengers to either meet or fund. Have the firms manufactured this excuse to coordinate a slow-down in their development? Two things can be true at once.

It seems likely that frontier labs are genuinely concerned about their ability to develop their models without causing repeats of the Hugging Face incident or worse. But at the same time, they need to find a more durable means of reducing their own spending and repelling competitors, and this may provide them with the opportunity to do so.

If this were to happen there would be many implications. Lots of headlines have been written about how dependent the U.S. economy is on AI capex (capital expenditure). Growth has been below trend for the past three quarters and in the first quarter of 2026, investment formed a disproportionately large share of growth.

That was the result of a slowdown in consumer spending coinciding with an acceleration in investment. Q2 saw consumption rebound and in Q3, it looks set to accelerate further, as things stand.

Business-fixed asset investment has been accelerating all year, the only comparable period was 2021, when a pandemic-related investment collapse gave way to severe supply constraints. Information technology now makes up a record 5% of U.S. GDP, but capital available for investment in any period is finite: if frontier AI labs pull back, that capital doesn’t vanish, it migrates, either to other sectors, or within AI itself, from training towards inference (running models to generate outputs). Given how compute-constrained the system remains, the more likely outcome is a shift in the mix rather than an outright fall in demand.

Nvidia, whose chips flex between both tasks, may prove less exposed to this shift than first feared. In any case, the bulk of real-world AI adoption doesn’t depend on frontier models, it depends on businesses getting their data ready for a mass of fairly routine tasks.

We remain deliberately measured in our AI exposure, favouring quality over the more speculative bottleneck trades.

Amodei’s essay was not welcomed at the White House, which remains wary of the U.S. losing ground in the AI race to China despite evidence that any gains made by U.S. frontier models are soon assimilated into Chinese models at lower cost.

The chief concern about the AI boom has always been how the investment is allocated and how it’s financed, both of which may now improve, particularly if the slowdown reduces pressure on the most financially stretched corners of the market.

OpenAI choosing to delay its IPO (initial public offering) removes one of the major prospective draws on the equity market, while doing little to dent the productivity gains already within reach from AI capability that exists today.

Credible threats

These decisions could affect the outlook for inflation going forward. For now, central banks have been focused on the here and now, with U.S. inflation having exceeded target for more than sixty months.

Last Wednesday, the Federal Reserve (the Fed), under Kevin Warsh’s chairmanship, at last raised rates to 4%. Notably, the decision was unanimous.

We had been led to expect a more fractious committee, closer to the Bank of England’s habitual splits, so the united front carried weight. Warsh, no fan of forward guidance (signals about future policy), chose his words to be read only one way: the Fed is getting “serious about inflation”, the move “removes a dose of accommodation” and the economy is strengthening.

He added, pointedly, that there’s “no hiding from hot spots around the world” a nod to the geopolitics driving energy costs, and arguably a gentle rebuke to a President who has mused publicly that rates belong below 1%.

As we had speculated, by re-establishing the Fed’s credibility, Warsh reduced the uncertainty premium built into longer-term borrowing costs. Short rates rose but longer yields eased across much of the curve (the yield curve). 

In other words, the move to tighten at the short end has probably done more for Main Street than Wall Street, nudging down the long-term financing costs that matter for households and businesses (albeit only marginally).

Bank of Japan

The Bank of Japan also raised rates, to 1.25%, in a 7-2 vote. Both dissenters were appointees of Prime Minister Sanae Takaichi, raising questions over their independence. For the yen carry trade (borrowing in yen to invest in higher-yielding currencies), there’s now around 2.5% pickup available for anyone borrowing yen and saving in dollars.

U.S. Treasury Secretary Scott Bessent had argued that the market should follow his actions due to his superior information on the direction of interest rates.

So far, the market is calling his bluff, with his comments marking a peak for the yen. All else equal, investors can borrow in yen and invest abroad, and with U.S. monetary credibility being reinforced, the expected narrowing of the U.S.-Japan rate gap is not happening. Bessent’s interest in this stems from Japanese holdings of U.S. treasuries. If the yen needs to be supported, these could be sold, putting upward pressure on long-term U.S. interest rates.

A hawkish hold

All the interest rate decisions have been broadly as expected, with focus ending up on the nuances around comments and voting patterns.

The Bank of England (BoE) held rates at 3.75% on a 6-3 vote, much as economists expected. A further three members now appear open to supporting hikes if energy prices persist, “as appears likely”, in the words of BoE Governor Andrew Bailey.

The gap between what markets price and what economists forecast remains striking. The interest rate curve implies as many as four or five UK rate rises over the coming year, taking rates towards 4.7%. Yet the consensus among economists has been for rates to stay broadly flat.

This isn’t necessarily a contradiction. Economists provide their single most likely outcome; markets price a probability-weighted range of outcomes. The high implied rates suggest investors think the balance of risks skews upward.

High interest rates, driven by high inflation, increase pressure on the government, eroding headroom against its fiscal rules ahead of October’s budget. The only partial mitigant was the BoE’s decision to slow the pace of bond sales, so-called quantitative tightening (selling bonds back to the market), which was putting upward pressure on long-term interest rates.

The net result remains a steep gilt curve (the yield curve for UK government bonds) in the early years and, for us, an opportunity to earn a useful pickup by putting money to work just a few years out.

UK resilience

The UK economy, for its part, is proving more resilient than feared.

Retail sales rose 0.5% on the month in August, and the increase was broad rather than one-off households are still spending despite higher fuel and borrowing costs. 

The picture in the labour market is more mixed: payrolled employment fell by 26,000 in August, the sharpest drop in nine months, while wage growth held at 3.9%. Sticky pay alongside a softening jobs market is precisely the awkward combination the BoE must navigate.

But the U.S.-Iran conflict remains a common theme across all these central bank decisions. Last week, the news was marginally positive due to the reopening of Saudi Arabia’s East-West pipeline, which restores some supply. 

Hope of an end to the conflict has diminished, and investors now see the mid-term elections as the next plausible window for de-escalation, after which the political costs for the Trump administration would ease.

However, it is very hard to know how well the Iranian regime is coping with the loss of oil revenue, or whether further pressure can be brought to bear.

What’s coming up?

The dragon and the eagle: 

Chinese President Xi Jinping is meeting President Trump on Thursday 24 September.

Confidence conference: 

The U.S. Treasury Market Conference takes place in New York on Tuesday as yields rise and the Treasury intervenes in markets.

Taking the temperature: 

Provisional PMIs (purchasing managers’ indices) will hint at the economy’s resilience to current energy prices.

Bond markets were at the centre of market moves last week, with global government bond yields rising sharply across developed markets. The U.S. 10-year Treasury yield moved close to 5%, while UK gilt yields reached nearly 5.4%, a level not seen since 2007.

The immediate catalyst was another rise in energy prices, a result of the conflict in the Middle East intensifying. Escalation in Iran-U.S. tensions has pushed Brent crude oil prices back above USD100 a barrel, while U.S. diesel prices have moved to over USD6 a gallon.

Higher oil prices have renewed concerns about inflation and pushed investors to expect more interest rate hikes. But we think oil is only part of the story.

Governments are borrowing heavily to fund large fiscal deficits. At the same time, the enormous investment required to build AI infrastructure is creating another source of demand for capital.

Put simply, there are a lot of borrowers competing for the same pool of money. Investors are therefore demanding higher yields to lend for 10 or 30 years.

This is also why the U.S. Treasury’s latest bond buyback failed to provide much relief. Buybacks can improve liquidity and help supply and demand at the margin, but they can’t address the fundamental issue of large fiscal deficits, heavy government borrowing and persistent inflation.

This is broadly consistent with our view that the latest geopolitical shock is only one part of a bigger, longer-term shift in bond markets.

For equity investors, higher yields are a near-term headwind. When investors can earn close to 5% from U.S. government bonds, equities face more competition for capital. Higher yields also reduce the present value of future corporate earnings, which can be particularly challenging for more highly valued growth stocks.

This doesn’t change our longer-term constructive view on equities. But while bond yields remain elevated, we think equity markets could remain more volatile.

U.S. inflation adds interest rate pressure

The U.S. inflation reading adds pressure on the Federal Reserve (the Fed) to raise interest rates this week. Headline Consumer Price Index (CPI) inflation was broadly in line with expectations, coming in at 3.4% year-on-year, while annual core inflation eased slightly to 2.4%, the lowest since March 2021. But the more closely watched core CPI rose +0.3% month-on-month, above the 0.2% expected and the biggest increase since April.

This CPI data doesn’t yet capture the latest surge in oil prices, much of which occurred in the first half of September. Higher energy costs can also take time to feed through into other parts of the economy. 

Meanwhile, producer prices released last week pointed to continued pipeline inflation pressure and the latest U.S. jobs report was strong, both reinforcing the case for elevated inflation.

All this data adds pressure on the Fed to do its job to constrain price pressures.

Markets have responded quickly. Earlier this month, markets priced in a 70% probability of an interest rate hike, which rose to 90% immediately after the CPI release.

Interestingly, bond yields came in a bit lower and stocks reacted positively. The read is that if the Fed follows through with a rate hike, it will help restore its inflation-fighting credibility, anchoring long-term inflation expectations, which markets would welcome as a positive development.

The ECB turns more hawkish

The European Central Bank (ECB) added to the more hawkish backdrop last week, raising its deposit rate by 25 basis points to 2.5%, which was widely expected.

More important was its outlook. The ECB revised up its inflation forecasts, with inflation now expected to average 2.5% in 2027 and 2.1% in 2028. At the same time, it upgraded its growth forecasts for this year and next, reflecting a more resilient Eurozone economy.

That resilience is important. Higher energy prices are hurting consumers and businesses, but so far, the economy has held up better than feared. This reduces the immediate risk of stagflation and gives the ECB more room to focus on inflation.

Markets have responded by pricing in more rate hikes. However, we think there is a risk that markets are overestimating how much tightening will ultimately be needed.

The key is wages. So far, there’s little evidence that higher energy prices are creating a second-round wage-price spiral. Eurozone compensation growth has slowed, while the ECB’s wage tracker points to only a modest 2.7% increase in negotiated wage growth in the first half of next year. Longer-term inflation expectations also remain anchored at around 2%.

And this is not just a European story. U.S. wage growth eased to 3.1% in August, while UK private sector wage growth has slowed to 2.8%. Resilient economic growth means central banks cannot ignore the inflation shock, particularly if oil prices remain high. But slowing wage growth suggests the second-round effects are not there yet.

That means central banks may need to remain hawkish in the near term, without necessarily delivering as many rate hikes as markets currently expect.

Given the ECB’s rate hike, the recent data and market pricing, it will be a surprise if the Fed remains on hold this week. If it does not, it will face serious credibility challenges and Fed Chair Kevin Warsh will need to explain its rationale clearly to the market.

What’s coming up?

Fed meeting:

The Fed’s next policy meeting on 15 and 16 September will determine whether a rate hike will be actioned – with a nearly 90% probability priced in.

Bank of England (BoE) policy meeting:

Markets expect the BoE to stay put, with the combination of higher energy prices and a weaker job market causing a policy conundrum.

Developments in the Middle East:

Several Gulf states are planning a meeting with Iranian officials this week to discuss the future of the Strait of Hormuz.

As summer draws to a close, the heat remains for the world’s major central banks. This month, all of them set rates and for once, the outlook points in different directions.

The U.S. attempted to set the tone a couple of weeks ago, when Federal Reserve (the Fed) Chair Kevin Warsh spoke at the Jackson Hole Economic Policy Symposium. His message was uncompromising: the inflation target is not up for negotiation and rates may need to rise.

The market reaction was striking, with the dollar rallying and gold and bonds easing. Having talked tough on inflation before without following through, with his own credibility already under scrutiny, any hint of softness should have been unthinkable. The implied odds of a U.S. rate hike moved from possible to probable.

It is consumer price inflation rather than an overheating jobs market that’s pressing the Fed into action. This message was underscored by a full week of U.S. labour market data, which suggested lower staff turnover as staff feel less confident about being able to move to higher-paying jobs. Meanwhile, surveys suggested staff demand remains healthy.

That culminated in a stronger-than-expected jobs report showing 167,000 new jobs created in August, and a small upgrade to last month’s surprisingly weak report. It is likely enough to spur the Fed into action even though wage growth remained modest, and the unemployment rate was unchanged, with labour force participation increasing.

A different kind of U.S. policy shift occurred in relation to the Iran war. Having announced a shift from military to economic pressure, the U.S. has been drawn back into hot conflict, putting further upward pressure on consumer prices.

Europe’s gas problem returns

European bond yields pushed higher over the week as gas futures climbed on fears of supply shortages. Inventories have been low for the season, as buyers held off in the hope that peace in the Middle East would bring prices down. With the regional conflict dragging on, those hopes have been dashed.

It has been easier for crude tankers to navigate the Strait of Hormuz, but shipping of liquefied natural gas (LNG) remains severely impaired given the danger of a potential strike on an LNG carrier (a specialised ship designed to transport liquefied natural gas).

Benchmark Dutch gas futures are now more than double their pre-war levels. For Europe, energy costs continue to drive the inflation story and help explain why the European Central Bank (ECB) is expected to raise rates next week.

The U.S. decision, which will be made in a couple of weeks, is tough to predict, but the central bank is expected to raise its federal funds rate. Meanwhile, the UK’s Bank of England (BoE) is likely to remain on hold. That is despite last week’s British Retail Consortium shop price index showing the second-round effects of earlier energy price increases continuing.

However, retail activity remains subdued, and house prices have softened. Even the business surveys show momentum is fading and with UK interest rates being amongst the highest of developed markets, the BoE perceives them as restrictive.

Leaning into gold

Gold had been weighed down by negative momentum and worries over central banks drawing down reserves during the U.S.-Iran conflict. That has given way to renewed interest in the debasement trade, the idea that persistent fiscal pressures erode the value of paper money over time. Warsh’s hawkish speech knocked gold temporarily and fresh hostilities with Iran added a further headwind by slowing reserve accumulation.

Debasement can come through Fed inaction; but the greater concerns are around the Fed’s independence being undermined. In the absence of something transformative happening to the national debt, debasement will remain the path of least resistance and we’re happy to let the gold weighting float higher.

Correspondingly, we remain underweight in bonds. Long-term yields have been rising due to uncertainty about the future path of interest rates and inflation. A credible Fed, one that convincingly anchors inflation, would be helpful in restraining yields in time that probably starts with a September hike.

On equities, valuation remains the perennial worry. U.S. cyclically adjusted valuations sit close to prior peaks, though they’ve been higher in other markets before. Look beneath the surface and the picture is more balanced: just over half of S&P 500 companies trade on lower price-to-earnings ratios than their five-year average.

The aggregate multiple has crept up largely because a few high-priced names, Tesla among them, now carry more weight, but some of the biggest and best performing stocks have become significantly cheaper because their prices haven’t risen with their earnings. This shows that investors are questioning whether this extraordinary run of earnings can be sustained.

The past two quarters have beaten even year-ahead forecasts, something usually seen only coming out of a shock. This sets a demanding bar for next year’s comparisons but also suggests that analysts have been expecting a cyclical slowdown during what’s so far been a period of secular growth.

Last week saw Nvidia reporting earnings, which effectively lowers the curtain on the second-quarter earnings season. That means fewer obvious catalysts for uplifts until October, when third-quarter numbers begin to arrive. So, while the flow of corporate news ebbs, the controversies that remain are over what appear to be objectively high valuations and unproven business models.

For some time, market milestones have invited comparisons with valuations of the past. Over the summer, the Financial Times observed that U.S. equity valuations now sit higher than in September 1929, surpassed only by the peak of the dot-com bubble. It is a comparison that demands respect, and we take the underlying caution seriously, however context matters.

The metric being cited is the analytically useful, cyclically adjusted price/earnings (CAPE) ratio, which measures the real price over the 10-year average adjusted earnings (with both price and earnings adjusted for inflation). 

While U.S. valuations have only reached today’s levels once before, during the tech bubble, there’s still a further 26% upside to the peak they eventually reached. Look beyond the U.S., though, and valuations are far less stretched. Global equity valuations are dragged down by their weighting towards other regions.

Anchoring to the tech bubble valuation peak is also unhelpful because the peak for equity valuations was neither in the U.S. nor in 1999, it was in 1989 Japan, when valuations reached multiples of the highest levels.

The deeper point is that valuations are just numbers that need to be reconciled against the pace of profits growth, not just their level. In early 2000, the market’s largest company, Microsoft, briefly touched earnings growth near 80%. 

Today’s largest, Nvidia, has now enjoyed multiple years growing much faster than that. Its valuation seems high looking backwards, as CAPE does, but less than 20 times 2027 earnings does not seem demanding.

Its results, announced last Wednesday night, were strong, with quarterly revenue close to doubling year-on-year and a first-ever full-year forward guidance of 70% growth, which is only that modest due to supply constraints.

Is the AI trade resting on shaky foundations?

The more interesting debate is subtler. The performance gap between the frontier AI labs, OpenAI, Anthropic and cheaper open-weight models has narrowed sharply, from perhaps 12–18 months to as little as three to six. 

That threatens the labs’ pricing power and they’ve made vast spending commitments to the hyperscalers (large cloud providers) who host them. Microsoft alone carries roughly USD281 billion of contracted backlog tied to OpenAI, part of a group total near USD700 billion.

So, it does make sense to wonder: what would the impact be if OpenAI and Anthropic found they couldn’t charge premium prices for their premium product? How does this affect the hyperscalers? Our read is measured.

Microsoft’s Azure platform is deliberately model agnostic. With over 11,000 models available, its economics are driven by total utilisation rather than any single customer. If OpenAI stumbled, that capacity would be redistributed to the enterprise demand queuing behind it, after a digestion period. Reduced demand from the AI labs, or reduced demand because of gains in model efficiency, would enable hyperscalers to slow their capital expenditure (capex).

So, does the real risk lay with the recipients of that capex? Back to the likes of Nvidia, which may also be at risk from greater efficiency in custom silicon as well? It is a risk, but historical examples of this kind of technology show that efficiency gains tend to unleash more demand than they destroy.

Jevons’ paradox noted that as steam engines became more efficient, rather than reducing coal demand, they increased it because steam became a much more accessible technology. So far, that pattern seems to be holding for AI too. For Nvidia, cheaper open-weight models running on its highly flexible platform are a tailwind, not a threat.

Restoring credibility

It is an open secret that public officials don’t always end up keeping their promises, but it feels like recent years have seen an unusual amount of policy flexibility. The UK’s debate over what increased taxes might mean for working people contributed to the change of its government. The U.S. plan to end military interventions has seen it mired in war in the Middle East.

Central bankers are assumed to be immune from the political pressures that lead to policy flexibility, but they can’t escape the financial pressures. So, inflation remaining persistently above target and governments delivering persistent budget deficits have created concerns that monetary policy is being directed at eroding debt burdens rather than managing inflation, a state known as fiscal dominance.

The relatively new Federal Reserve (Fed) Chair, Kevin Warsh, had the job of rebutting such concerns at last week’s Jackson Hole Economic Policy Symposium. He did so forcefully, acknowledging that inflation has not meaningfully slowed and that the Fed has work to do. 

He reiterated the inflation target, said that short-term interest rates are the primary policy tool and acknowledged that the economy had strengthened. Without explicitly offering guidance, he gave the distinct impression that a rate hike was likely in mid-September.

That prospect saw a strong U.S. dollar and weaker bonds as Warsh affirmed the Fed’s commitment to controlling inflation with higher interest rates. That weighed on gold as it indicated the Fed won’t facilitate further inflating away national debt.

However, a lot could happen this week to tip the scales for or against a rate hike. A host of jobs data will come in on Friday, including the non-farm payrolls report, which was surprisingly downbeat last month.

What’s coming up?

Jobs news: 

If Friday’s employment report shows a rebound, interest rate hikes could be back on the agenda.

Global PMIs: 

Provisional purchasing managers’ indexes showed modest momentum loss in an ongoing expansion, but full data will provide more detail.

Question time: 

The UK prime minister faces his first prime minister’s questions, riding a poll bounce.

A recurring concern for investors during extraordinary periods of expansion has been the sustainability of debt. How can the good times continue when the debt-to-GDP (gross domestic product) ratio keeps increasing and with it the share of tax revenue being spent on interest payments alone?

The maths is straightforward, if uncomfortable. The most obvious way a government can improve its debt position is by cutting spending or raising taxes, but these are both politically thankless, whether you lean left or right. And while there was a brief period following the Great Financial Crisis in which fiscal repair was not completely rejected by voters, those halcyon days have passed.

For example, Atul Bhatia from the RBC Brewin Dolphin U.S. fixed income team describes U.S. policymakers as “one-way Keynesians”, they ramp up spending during economic shocks (such as a global pandemic), but neglect to run a corresponding budgetary surplus during better times.

If spending cuts and tax rises are politically untouchable, the only remaining route to lowering debt is by widening the gap between growth and borrowing costs. An optimistic scenario is that an AI miracle results in high growth and lowers inflation and therefore interest rates, allowing countries to outgrow their debt. While this is possible, it’s but one possibility. 

A particularly vigorous AI revolution could, for example, result in lower employment and higher benefits payments, which would have quite a different impact on public finances.

What does seem likely though, partly because it’s already happening, is that governments can achieve the same result with nominal growth (which includes inflation) rather than real growth. It’s quite customary for nominal growth to exceed interest rates, allowing countries to either pay down debt or, more commonly, run fiscal deficits. Widening that gap would give policymakers more palatable options.

To see this in action, Japan, the most indebted major economy in the world, has trimmed its debt-to-GDP ratio since 2020 by precisely this route: inflation has risen faster than interest rates even as the country continued to run a budget deficit.

With that in mind, U.S. Secretary to the Treasury, Scott Bessent, confirmed it would at least double its buybacks of outstanding 10-year to 30-year debt, lifting operations from $2 billion to $4 billion. That saw a rally in the bond market. It was short-lived, but the buybacks announced won’t start until September, so this doesn’t mean it’s been futile.

When long-dated Treasury bond buybacks first began under former Secretary to the Treasury, Janet Yellen in 2024, ostensibly to manage liquidity, they were considered controversial by some. But last week’s events seem to connect the policy to the management of bond yields (interest rates). 

It comes shortly after the U.S. sold euros to buy yen to spare Japan from selling its U.S. Treasury holdings. Demand for Treasuries is also being supported in other ways, such as making it easier for banks to hold them and potentially creating demand as collateral for stablecoins.

Now it seems possible to join the dots and see steps being taken towards a regime in which above-target inflation is tolerated, and low interest rates are targeted to ease the servicing, or even reduction, of debt. 

Over the long term, this creates opportunities in the form of a steeper yield curve. This would weigh on the dollar relative to less repressive currencies and would highlight the attractions of real assets with limited supply, such as gold.

The implication for portfolios is one we’ve been building towards for some time. If governments lean on inflation to manage their debts, longer-dated bonds look vulnerable, there’s overwhelming pressure to cap yields, but little natural limit on how much debt can be issued. 

Assets, whose supply is genuinely constrained (gold being chief among them), become more appealing by contrast. 

UK ‘stagflationary’ pressure remains

Closer to home, UK inflation data for July came in at an annual rate of 2.9%. It’s the first rise in four months and a touch above expectations on the core measure.

These figures were the first to reflect higher household utility bills due to the U.S.-Iran conflict and because of the lagged impact of the regulatory price cap. Fortunately, that landed during a month when fuel costs fell.

Beneath the surface, the signals are mixed: services inflation eased to 3.4%, but that was largely airfares and the Bank of England’s (BoE) preferred underlying measure, the Consumer Price Index, actually rose to an annualised 2.9% in July, up from 2.6% in June.

Another way of gauging underlying pressure is the median category price change, which reached its highest level since mid-2025, suggesting inflationary pressure remains.
Despite this, there’s definitely a better mood in the UK at the moment, which seems to have coincided with new Prime Minister Andy Burnham having a more optimistic tone.

Consumer confidence rebounded to its highest since 2024, notably, the strongest reading under the current government. Yet retail sales slipped slightly, flattered only by a World Cup boost to food and drink. Public finances continued to show how difficult the new chancellor’s job will be ahead of October’s budget.

Employment data released last week told a similar tale of tension: payrolls fell for a second month, and vacancies hit a five-year low, yet wage growth held firm at 3.5%. That awkward combination, slack in jobs, stickiness in pay, has left markets expecting the BoE to hold interest rates at its next meeting in September.

What’s coming up?

Nvidia earnings: 

The American tech company will release one of the most closely anticipated earnings results as the second-quarter earnings season draws to a close.

Jackson Hole: 

Central bankers will be heading to Jackson Hole for the annual Economic Policy Symposium, where Fed Chair Kevin Warsh will speak on Friday.

U.S. inflation:

The Fed’s preferred measure of inflation – the Personal Consumption Expenditures Price Index – is released.