The Fed hikes, the Bank holds, and gilts rally
The Fed raised rates for the first time since 2023, the MPC held, and the gilt market rallied on both. Plus an oil spike that is already unwinding, what the Bank’s minutes concede about second-round effects, and the AI chiefs who want to slow down.
First published in Noise Cancelling
As expected, it’s been a busy week with quite a lot going on. The oil price continued to rise at the start of the week but has since fallen, and appears to be trending back down towards $100 a barrel. The Fed has chosen to increase interest rates, which I had hoped it wouldn’t, while the MPC has held rates, which is what I expected, with the 6–3 vote bang in line.
There has also been quite a lot of AI news this week, which I will cover only briefly here because our latest Noise Cancelling podcast covers the topic in a lot more detail.
An oil spike that is already unwinding
Since the start of September, the oil price has risen from about $90 to a peak earlier in the week of just below $110. It has since fallen again and is today just above $100 a barrel. I wrote about this in last week’s update and suggested there was something odd happening in the oil market, because the flare-up in hostilities in the Gulf didn’t on its own explain a 20% move, especially against a backdrop of increasing volumes of crude leaving the Gulf through the Strait of Hormuz.
This week the US energy secretary, Chris Wright, said that almost exactly 18 million barrels of oil passed through the Strait on 1 September, revising up the figure he gave at the time. I am firmly in the camp of not believing everything US politicians say, but the consistent theme, which is backed up by independent analysts, is that increasing volumes are leaving through the Strait. Saudi volumes have increased via this route following the “temporary” closure of its East-West pipeline to the Red Sea after a drone attack last week. I suggested the spike might have been caused by China returning to the market, but this was just a guess. Either way, I thought the move looked odd then, and it does appear to have been unwinding over the last few days.
Whatever the cause of this latest spike, it has created concern among central bankers, politicians and the financial markets, and was reflected in higher bond yields everywhere until yesterday’s Fed rate decision. The day-to-day volatility of this ongoing conflict is impossible to predict, but if the US perspective is accurate, I would expect the spike to unwind further in the days ahead. Given the importance of fuel prices to US voters, I would imagine that it is also President Trump’s number one priority ahead of the midterm elections in early November.
The Fed raises, and the bond market calms down
As I have said, concerns about the oil market and its impact on inflation were front and centre in financial markets in the days leading up to the Fed’s interest rate decision on Wednesday. Even so, I was a little surprised by how spooked bond markets were in the run-up to the meeting, and I have been just as surprised by the rally since the decision was announced, particularly in the UK. But first, the decision itself, which is what the market expected and wanted. I still maintain it was unnecessary, but if it leads to lower yields because it calms those most concerned about the outlook for inflation, it will have served its purpose.
The Fed chairman, Kevin Warsh, accompanied the decision, which was unanimous, with appropriately soothing words for the bond market, including: “This summer’s inflation readings do not tell me that underlying trends have meaningfully improved.” On reflection, though, the fact that the President has been so vocal about the need for lower rates, and that his choice of chairman has presided over the first increase since 2023, has probably taken some of the political risk premium out of the market. That may explain the rally since.
The MPC holds, and gilts rally
Back in the UK, as predicted, the MPC voted to hold rates today at 3.75%. For me, this is unequivocally the right decision, and it was welcomed by the gilt market with a further rally, which had started the day before following the Fed’s announcement. Ten-year yields, which spiked on Tuesday to just under 5.4%, have since fallen to just above 5.2%. That doesn’t sound much, but it is significant given the decision was exactly what the market had anticipated.
This decision, and the reaction in the gilt market, will be especially welcome in Downing Street, where the pre-budget arithmetic would have been looking pretty ugly on Tuesday. I am not sure it looks that rosy today, but even this small shift down in ten-year yields will be moving the OBR’s conditioning assumptions in the right direction.
One thing regular readers will not be surprised by is that the US and UK bond markets continue to move in lockstep. The yield premium on the UK ten-year bond has come in a bit and is within its long-run range at 27bps as I write, well below the long-run average of about 42bps. This latest move further undermines the fiction that there is some kind of growing risk premium in the market reflecting global investors’ concerns about the state of the nation’s finances. The truth is quite the opposite.
The gilt premium is below its forty-year average
What the Bank now concedes
Before moving on to this week’s potentially frightening AI stories, I want to end this section by highlighting some interesting comments in the minutes accompanying today’s decision. The first thing that stood out was the comment about second-round effects. As ever, the Bank will go out of its way not to say it was wrong about anything, but it has said the following:
The indirect impact of higher energy prices through firms’ supply chains onto CPI inflation was judged to have been small to date, and less than expected at the start of the conflict. This was particularly evident in weaker-than-expected food price inflation.
Along with some rather long-winded guff about the labour market and slack in the economy, this can be interpreted as: the second-round effects of the oil price shock were not what we expected. Which is pretty much what I’ve been saying since the war started.
I was also interested to see that the Bank has raised its Q3 growth forecast from 0.1% to 0.4%, which is something I have written about recently. (The 0.1% was what the Bank was saying as recently as July, by the way.) Once again, though, the Bank seems to have forgotten that earlier in the year, after Q1 growth of 0.6% blew its 0.1–0.2% forecast out of the water, it suggested the outcome had been flattered by the pattern of unusually strong first quarters of recent years, and that demand had merely been brought forward into Q1 from future quarters. That now completely contradicts this Q3 upgrade. In other words, the Bank’s growth forecast was wrong, as was its inflation expectation. In both cases it was too pessimistic, once again.
The Bank’s growth calls keep coming in too low
| Quarter | Bank projection | Made in | Latest |
|---|---|---|---|
| 2026 Q1 | 0.2% | February Report | 0.6% |
| 2026 Q2 | 0.3% | July Report | 0.4% |
| 2026 Q3 | 0.1% | July Report | 0.4% |
The AI chiefs who want to slow down
Finally, to this week’s AI stories. It’s been busy, but in summary: after last week’s release of Anthropic’s interactive economic model, which we talk about in this week’s Noise Cancelling podcast, Anthropic’s chief executive, Dario Amodei, has called on the industry to slow the development of frontier AI models and to accept that they should be reviewed by independent third parties. His equivalent at OpenAI, Sam Altman, and Elon Musk have both backed him. This follows a couple of worrying incidents in which a swarm of AI agents bypassed safety rules and hacked into another company without any human intervention.
The proposal was not welcomed by President Trump or by the Chinese leadership, despite the fact that some leading AI researchers have suggested AI’s rapidly advancing capabilities carry a real risk of human annihilation before the end of this decade.
On this rather cheery note, I shall draw this update to a close, but not before reminding readers interested in the subject that we cover it in this week’s Noise Cancelling podcast.
What to look out for next week
There are still some important macro data releases tomorrow on both sides of the Atlantic, which I will cover, if necessary, in next week’s update. Next week is thankfully quiet, with nothing of great significance in the UK but some important US labour market data on Thursday.
The lull in the corporate calendar continues, and there won’t be much to write about until the full Q3 results season kicks off in mid-October.
Important information
The views expressed in this article are those of the author at the date of publication and not necessarily those of Curated Capital Ltd. The contents of this article are not intended as investment advice and will not be updated after publication unless otherwise stated.
