Week Ahead: Bond Yields, Fed and ECB Minutes in Focus

Weekly wrap

Global indices were volatile last week as rising oil prices and bond yields intensified inflation and interest-rate concerns. However, U.S. equities recovered in the second half of the week following cooler-than-expected U.S. core PCE data and a weaker-than-forecast non-farm payroll report, which eased expectations of another Fed rate hike. Just 29,000 jobs were added in September, well below the 90,000 forecast, while the unemployment rate unexpectedly rose to 4.2% from 4.1%.

The Nasdaq rose to a record high on strong AI demand, while the S&P 500 slipped 0.3% across the week. The Dow Jones and European equities endured another difficult week. The U.S. dollar rose almost 1%, marking its third consecutive weekly gain as it trades at 15-month highs.

The main focus remained on Treasury yields, which stayed elevated. The U.S. 10-year yield reached 5.34%, its highest level since 2002, and recorded its strongest monthly gain in around two years. UK gilt yields and French bond yields also surged as fiscal concerns intensified.

By the end of the week, market pricing showed only a 20% probability of an October rate hike, down from 65% a week earlier. However, the market was still pricing an 87% probability of at least one rate hike before the end of the year.

US Services PMI and FOMC minutes

Following the cooler inflation and payrolls data, and the sharp rise in bond yields, attention will turn to U.S. services PMI data at the start of the week, together with consumer sentiment, which could provide further clues about the health of the U.S. economy.

The interest-rate outlook remains the biggest headwind for stocks as they enter the first full week of Q4, which has typically been a strong period for U.S. equities. However, that seasonal strength faces several challenges, including elevated bond yields, dependence on AI spending and the looming midterm elections.

The Fed's monetary-policy plans will also be in focus, with the minutes from the September meeting released on Wednesday. This was the meeting where the Fed hiked interest rates for the first time in three years in an effort to cool above-target inflation. The minutes could provide further clues about the rate outlook, particularly after the dot plot showed 16 officials supporting another rate hike this year and amid Chair Kevin Warsh's reluctance to provide forward guidance.

Key Fed officials, including New York Fed President John Williams, have sounded more cautious about hiking rates too quickly. The key question for markets is whether the recent weakness in employment will be enough to offset persistent inflation and elevated yields.

Earnings from PepsiCo and Delta Air Lines will also be in focus before earnings season kicks off next week.

The S&P 500 is trading in a symmetrical triangle pattern. Buyers need to rise above 7,750 to bring 7,810 and fresh record highs into focus. A break below 7600 would see the price break down from the triangle bringing 7500 into focus.

Will ECB Minutes limit EUR/USD downside?

The ECB will also publish the minutes of its September meeting on Thursday. At the meeting, the ECB hiked interest rates by 25 basis points, while commentary since then has been mixed.

ECB President Christine Lagarde noted that higher Treasury yields could tighten financial conditions, potentially reducing the need for further policy tightening. As a result, market expectations for an October hike have fallen to just 25%.

Given fragile eurozone growth and the region's vulnerability to higher energy prices, the ECB can afford to wait until December before deciding whether to hike rates for a third time.

Eurozone inflation has also risen to 3.8%, while core inflation crept higher in September. The minutes could therefore provide further clues about how divided the ECB is over the path for interest rates.

The minutes come as the euro has fallen to a 16-month low against the dollar and could benefit from any hawkish signals. However, gains are likely to be limited given the eurozone's stagflationary backdrop, political concerns, vulnerability to higher energy prices and the continued strength of the U.S. dollar and U.S. economic exceptionalism.