Softer inflation, but the Fed hasn't won yet

Markets received seemingly reassuring signals from the United States, but evident tension remained beneath the surface. Inflation slowed, Wall Street found new support, and expectations of a Federal Reserve hike diminished. At the same time, however, the bond market continued to demand a high premium to finance US debt, while Japan and the Middle East added new sources of volatility.

In July, the US CPI increased by 0.1% on a monthly basis and by 3.4% on an annual basis, a slight slowdown compared to the previous month . The core figure was even more encouraging, falling to 2.5% . The following day, producer prices also confirmed the same trend: the PPI remained unchanged for the month, while the annual change slowed to 4.7% .

The market interpreted the combination as a sufficient signal to reduce the risk of an immediate new tightening. After the CPI release, the implied probability of a September hike fell to around 38% . Equities reacted positively: the S&P 500 gained 0.26% , while the Nasdaq closed up 0.54% , once again supported by technology and the artificial intelligence sector.

However, the picture has become more complicated with consumer spending data. Retail sales fell 0.6% in July, the first decline in nine months, while the most important component of GDP fell 0.4% . This isn't a recessionary figure in itself, but it raises a different question: if consumer spending begins to lose steam just as inflation remains above the Fed's target, the central bank must balance two opposing risks. Weaker demand reduces price pressures, but it may also indicate a less resilient economy than stock prices suggest.

Wall Street rises, Treasuries send a different signal

The bond market didn't fully share the positive reaction from equities. Treasury auctions showed that the long-term cost of capital remains a structural problem. The 10-year bond was placed at its highest auction yield in 19 years , while the 30-year bond reached its highest level in 25 years .

It's a significant divergence. Inflation data is leading investors to imagine a more cautious Fed, but another factor weighs on the long end of the curve: fiscal sustainability. In July, the US federal deficit reached $432 billion , bringing the cumulative deficit for the fiscal year to $1.799 billion . The deficit has thus already exceeded that recorded for the entire previous year, despite the fact that there are still two months left before the end of the fiscal year.

With government bond supply expected to remain high, investors are demanding higher yields to absorb new duration. The message is therefore less dovish than it appears when looking solely at the Fed: even with official rates held steady, the cost of financing for households, businesses, and the government may remain high. This is one of the reasons why the stock market rally continues to coexist with a rate structure that can hardly be described as expansionary.

Japan returns to the center of monetary policy

While the United States debates whether to halt the rate hike, Japan is moving in the opposite direction. Rumors emerging over the weekend have brought the possibility of a Bank of Japan rate hike as early as September back to the forefront, a scenario the market now attributes with a probability close to 80% . The possibility of a more rapid tightening has immediately put pressure on Japanese bonds and rekindled the debate on the yen.

The pressure comes primarily from prices. Japanese producer price inflation remained at 7.2% in July: an extremely high level for an economy that for decades had been battling the opposite problem, deflation. A weak yen, energy costs, and rising import prices therefore continue to be passed on to businesses.

For the BoJ, the challenge is no longer simply to normalize an exceptionally accommodative monetary policy, but to prevent imported inflation from consolidating. Accelerating rate hikes would have effects far beyond Tokyo: higher Japanese yields could make it less profitable to finance global yen positions and alter flows to Treasuries and other bond markets.

Oil: Geopolitics and demand are pulling in opposite directions.

Tensions remained high on the energy market. Contacts between the United States and Iran failed to yield significant progress, and the Strait of Hormuz remains the main point of fragility for global supply. The difficulty in reaching a stable agreement and renewed tensions over shipping routes kept Brent crude in the $90 a barrel range, preventing the market from pricing in a rapid normalization of flows from the Persian Gulf.

However, demand has been holding oil prices back. OPEC has further reduced its estimates, bringing expected growth in global consumption to 580,000 barrels per day . This is the fourth consecutive downward revision and creates a stark contrast: supply remains threatened by war and logistics, while demand appears progressively less dynamic.

For investors, this balance remains unstable. An easing of tensions with Tehran could quickly remove part of the geopolitical premium embedded in crude oil; conversely, renewed problems in Hormuz would make demand revisions almost secondary in the short term.

A more fragile market than the highs suggest

The current picture therefore depicts a market buoyed by the hope that the Fed will step down, but still exposed to very different risks. US inflation is slowing, consumer spending growth is showing signs of slowing, and Wall Street continues to benefit from technological strength. At the same time, deficits and Treasuries are a reminder that borrowing costs remain high, Japan is approaching a new monetary tightening, and oil remains dependent on one of the world's most sensitive geopolitical corridors.

The stock market highs, therefore, do not depict a risk-free environment: rather, they reflect a market that, for now, considers manageable tensions on the interest rate, debt, and energy fronts that remain far from resolved.