Market Brief: Equity market turbulence intensifies, sending dollar reeling

Shares are sliding and the dollar is tumbling against its main counterparts as an unwinding of crowded AI-related trades sends investors fleeing to safe havens. US equity markets are setting up for further losses at the open after technology shares suffered their worst sell-off in months yesterday, Treasury yields are falling, while the yen and Swiss franc outperforming the euro, pound, and Canadian dollar as the retreat from risk gathers momentum.

Yesterday’s data added to the turmoil, showing that price pressures in the US economy remain too intense, too widespread, and too persistent. A widely-anticipated consumer price index report showed inflation rising by more than expected for a second consecutive month as increases spread beyond energy into goods, shelter, and services categories. The Fed’s Beige Book, published later in the day, pointed to further strain ahead, with businesses reporting plans to raise prices in the coming months as the war with Iran, tariffs, and immigration controls combine to push up the cost of producing, shipping, and distributing products.

Odds on a rate hike at the Federal Reserve’s October meeting are up, but the dollar is falling, prompting observers to offer a number of explanations. Some argue that the inflation surprise drove yields higher, triggering turmoil in financial markets, thereby driving investors into the safety of Treasuries, depressing yields and narrowing interest-rate gaps with other currencies**. Others think expectations for American growth are being marked down, as investors grow wary of the AI build-out and fear the Fed will tighten too far.

These explanations have a ring of truth, but we think something more structural is at work. Foreign investor exposure to American markets has changed over recent decades, with holdings that were once concentrated in debt instruments—mostly Treasuries—now weighted far more heavily towards equities. After a series of massive valuation shifts, those equity portfolios are themselves highly concentrated, with AI-related stocks now making up roughly half the S&P 500’s market value. This may mean that during mild selloffs, the dollar no longer behaves like a safe haven currency, and joins its high-beta counterparts** in acting as a proxy for overall risk sentiment.

The British pound is back on the offensive after the economy grew more quickly than expected in August, reinforcing expectations for a rate hike at the Bank of England’s meeting next month. According to the Office for National Statistics, gross domestic product grew 0.1% in August, adding to a 0.4% expansion in July and defying expectations of a contraction as manufacturing and computer programming lifted overall output. With inflation well above target and central bank officials voicing increasing concern about potential spillovers into other categories, markets are putting the probability of a November move above 90%, with a total of four hikes priced in by next September.

Ahead today: at 8:30, retail sales are expected to have risen 0.4% in September from the previous month, underlining the resilience of American consumer spending, even as sentiment levels plumb record lows. Headline producer prices, released at the same time, are seen rising 0.6%, while a measure excluding food and energy—an important input into the Fed’s preferred inflation gauge—is expected to climb 0.3%. At around 11:30, Fed chair Kevin Warsh will discuss the economic backdrop with IMF managing director Kristalina Georgieva at the fund’s annual meetings in Bangkok, with his comments parsed for insight into how policymakers are leaning ahead of the October 28 decision***.

*Circular explanations for market movements aren't new. See this from 1981.

**High-beta currencies are those that exhibit a highly-procyclical relationship with overall risk appetite, and are typically understood to include the Canadian, Australian, and New Zealand dollars, and Norwegian krone, along with some emerging-market units like the Mexican peso, Brazilian real, and South African rand.

***We still see it as unlikely that a majority of Federal Open Market Committee members support a rate hike at the October meeting, and expect Warsh to echo the cautious comments delivered by Williams and Waller early last week.

Economic Calendar