Bianca Botes, Managing Director at Citadel Global
Over the past quarter, central banks have been tightening into the Middle East energy shock rather than hoping it goes away. However, that proactive stance is rippling through to all other major asset classes.
Proactive rate hikes
The United States (US) Federal Reserve (Fed) raised the funds rate by 25 basis points to 3.75%-to-4% on 16 September, its first hike since July 2023, in a unanimous decision under Fed Chair, Kevin Warsh, despite White House pressure for lower rates. The European Central Bank (ECB) had lifted its deposit rate to 2.50% six days earlier, and the South African Reserve Bank (SARB) followed on 23 September with a unanimous 25-basis point increase to 7.25%.
None of these decisions was a response to overheating demand. Each was designed to stop the energy spike that followed the escalation of the US-Iran conflict from feeding into wages, inflation expectations and broader pricing, the mechanisms through which a temporary oil shock becomes a persistent one. With Brent up roughly 70% this year and back above $100/barrel on 1 October, policymakers have judged that waiting for evidence of those second-round effects carries more risk than acting before they arrive.
Bond yields tighten the noose
The bond market has done more of the tightening than the central banks themselves. As at the time of writing, the US Treasury 10-year bond was trading near 5.30% and the 30-year was near 5.65%, levels last seen in 2002. Yields in Germany, France and the United Kingdom (UK) sit at 17- to 19-year highs and the 10-year Japanese Government Bond yield has moved above 3%. When the benchmark against which every other asset is priced resets this far, the cost of capital rises for governments, companies and households at once and the liquidity that was abundant in the first half of the year has started to thin.
The rapid rise in rates has altered the way markets process information. While rates were falling or expected to fall, risk assets could absorb disappointing data because the prospect of cheaper money cushioned the impact. With the Fed’s September projections placing the median funds rate at 4.1% by year-end, implying a further hike before December, that relationship has inverted. Now, weak data will have no policy response to support it, while strong data raises the probability of additional tightening.
Tech equities at record highs
Global equities nonetheless remain within 2% of their record highs, and the explanation lies in earnings rather than sentiment, with S&P 500 earnings projected to grow by more than 30% this year, a pace unprecedented outside post-recession recoveries. Growth of that scale can absorb a rising discount rate, but only where it is concentrated, in this case technology, which is why the resilient index level conceals the narrowing market beneath it.
The tech-heavy NASDAQ 100 edged higher on 29 and 30 September while the equal-weight S&P 500 and small caps fell, with new lows outnumbering new highs by a wide margin throughout. Leadership came from the small group of artificial intelligence (AI) beneficiaries whose earnings are growing fast enough to outpace higher rates, illustrated by Micron’s quarterly revenue of $54.2 billion against $11.3 billion a year earlier. How the AI infrastructure development is funded matters as much as its scale, because Nvidia pays for its buybacks, dividends and equity-stakes in its own customers from internal cash flow, while the hyperscalers buying their chips increasingly issue debt to finance data centres, so that higher yields fall on the buyers of AI capacity rather than its suppliers. The strength, however, is far from global, since South Korea’s KOSPI fell almost 20% in the third quarter, its worst quarter since the pandemic, as chipmakers gave back part of the earlier surge.
The Fed’s response
Many investors have taken comfort in the assumption that Washington cannot absorb the financing costs of a 10-year yield above 5% for long, with federal debt above $40 trillion and a budget deficit of around $2 trillion a year. That intervention has already been attempted. US Treasury Secretary, Scott Bessent, expanded buybacks of long-dated bonds in August, tripled the size of the operation to $6 billion on 9 September and signalled a fiscal consolidation initiative, yet the 10-year crossed 5% on 14 September for the first time since 2023 and has continued higher. Bessent has acknowledged that Treasury cannot change the equilibrium price of government debt and can only slow disorderly moves and the market has treated the buybacks accordingly, as a liquidity measure that leaves inflation and fiscal concerns untouched, driving investors to demand more compensation for holding longer-term US Treasury bonds.
Walking the balance
Markets are consequently suspended between outcomes, waiting to see which pressure gives way first. Energy was the original catalyst, yet the bond selloff deepened in late September even on days when oil fell, which suggests the driver is shifting from the inflation outlook driven by oil prices towards the volume of government debt that investors are being asked to absorb, so that a lower oil price alone may no longer be sufficient to bring relief to US bond markets.
For South African clients the transmission is direct, with the SARB expecting inflation to remain elevated through 2027 and the resilience of the rand serving as the main buffer against imported fuel costs. Should rising US yields continue to support the dollar, as they did against the euro and the yen on 1 October, the rand strength becomes the variable to watch alongside oil and the US Treasury curve.
ENDS
