Just when it looked like the era of high rates was finally over, geopolitics deteriorated again, and of course, in key energy-producing regions.
On the one hand, Ukrainian attacks on Russian refineries have taken refining capacity offline, cutting Russian diesel exports by around 350,000 barrels per day. On the other, the conflict with Iran has added to the pressure, with diesel supply losses averaging around 770k barrels per day from March to August.
As a result, US retail diesel prices topped $6.50 per gallon for the first time, and since diesel affects everything from freight and agriculture to power generation, rail, and heating, inflation is unlikely to come down in the next reports.
Hence, central banks are becoming more hawkish, with the ECB raising rates by another 25 bps to 2.65% and projecting inflation at 3% in 2026, 2.5% in 2027, and 2.1% in 2028.
The Fed also raised rates by 25 bps to 3.75%-4.00%, its first hike since July 2023 and, importantly, a unanimous one, including Kevin Warsh, who some feared might heed Trump’s call for easier policy. Judging by the Dow futures reaction, markets seem to view the Fed’s independence positively.
Moreover, the Fed has signaled a higher-for-longer path, with rates expected to be 30 bps higher in 2026 and another 50 bps higher across 2027-28. Four members see another 50 bps of hikes, while the other 12 expect at least one more hike this year. For 2027, only four members see cuts, while eight expect rates to stay at 4.25%-4.5%.
In Japan, the central bank also raised rates by 25 bps to 1.25%, as expected, but two members voted against the move, and the statement was not particularly hawkish. The yen subsequently weakened again, with the USD/JPY exchange rate rising, while Japanese bonds remained under pressure, with the 10-year yield near 3% and the 30-year yield above 4%, especially amid a more hawkish Fed.
In the UK, the Bank of England kept rates at 3.75%, with six members backing a hold. Still, three called for a hike to 4%, and with the Bank expecting inflation to keep rising as higher energy prices feed through to the wider economy, further hikes may not be off the table.
As for what could ease hawkishness, besides resolving the crises in the Middle East and Ukraine, it’d be great to see the trade wars end.