The US economy has moved from resilient to uneven

The past week weakened the case for an immediate Federal Reserve rate rise, but it did not give bond investors the clean disinflationary signal they were hoping for.

US nonfarm payrolls increased by just 29,000 in September, well below the 90,000 consensus estimate. The previous two months were revised down by a combined 60,000 jobs, while unemployment edged up from 4.1% to 4.2%. Wage growth also cooled, with average hourly earnings rising only 0.1% during the month and 3.0% from a year earlier.

The details were somewhat less alarming than the headline. Labour-force participation increased to 61.8%, layoffs remained limited and the broader underemployment rate slipped to 7.6%. For now, this still looks more like a low-hiring, low-firing labour market than the beginning of a rapid employment contraction. The real danger comes if weak recruitment persists. Businesses facing higher financing and energy costs may eventually respond by freezing investment and leaving vacancies unfilled.

Inflation provided some relief as well. The PCE price index increased by 0.3% in August, below the 0.4% expected, while core prices rose 0.2% and annual core inflation held at 3.0%. Demand, however, hardly collapsed. Nominal consumer spending jumped 0.9% and real spending rose 0.6%. That leaves the Fed with an awkward mix. Inflation is moving in the right direction, but underlying demand is still too firm for policymakers to declare the job finished.

Markets responded quickly. The probability of an October rate rise fell from 64% a week earlier to below 20% on Monday. A pause is now the clear base case, although another increase in December remains plausible. This looks more like a postponement of tightening than a decisive return to easing.

Bonds are questioning the equity market's relief

Equities welcomed the softer employment report on Friday. The SPX500 gained 0.7% and the NAS100 rose near 1%. The weekly picture was less impressive. The SPX500 slipped 0.3%, the US30 lost 1.2% and the NAS100 managed a gain of only 0.55%. The market remains close to its highs, but much of the heavy lifting continues to come from technology and AI-related shares.

The bond market was considerably less relaxed. The US 10-year Treasury yield reached 5.34%, its highest level in roughly 24 years, before ending the week near 5.28%. Crucially, that was still above the previous Friday's 5.17%, despite weak payrolls and the sharp reduction in the probability of an October Fed move.

That divergence matters. If long-term yields were responding only to the Fed's next decision, weaker employment should have produced a more convincing Treasury rally. Instead, investors are still demanding compensation for inflation risk, government borrowing, huge AI-related capital requirements and uncertainty over where interest rates eventually settle.

Equity investors are effectively betting on a narrow soft landing. Employment weakens enough to prevent the Fed raising rates in October, but not enough to damage growth and corporate earnings. Bond investors appear less willing to believe that one soft payroll report can neutralise persistent inflation and fiscal risk.

Europe's inflation problem is colliding with France's fiscal problem

Europe's position looks considerably more uncomfortable.

Eurozone inflation accelerated from 3.2% in August to 3.8% in September, well above the European Central Bank's 2% target. Energy inflation jumped to 18.8%, services inflation increased to 3.2% and core inflation edged up from 2.4% to 2.5%.

Further ECB tightening remains firmly in the conversation, although the expected path has become less straightforward. The probability of a December increase is around 65%, while a number of major banks also favour December rather than October for the next move.

The problem is that Europe may be forced to tighten monetary policy while simultaneously absorbing expensive imported energy and growing political risk. This is not the benign sort of inflation associated with exceptional domestic demand. Much of it reflects a deterioration in Europe's terms of trade.

France has become the obvious pressure point. The premium investors demand to own French rather than German 10-year debt moved above 150 basis points, levels not seen since the eurozone debt crisis. The euro then sank to around $1.116 today, its weakest level in 17 months, as concern over France's debt burden and political gridlock intensified.

This is not yet a eurozone-wide funding crisis, and it should not be described as one. But the ingredients are uncomfortable. The ECB may need higher rates to contain inflation at precisely the moment when fragmentation is reappearing in sovereign borrowing costs.

That makes tighter policy a much more complicated signal. Instead of being read simply as evidence of economic strength, higher rates increasingly come bundled with worries over fiscal sustainability and financial stress.

Manufacturing is improving, but the recovery is unusually concentrated

There was better news from global factories.

September manufacturing surveys were generally stronger than expected. Eurozone manufacturing PMI rose to 52.9, its highest level since May 2022, while Taiwan's measure reached 56.7. South Korean exports posted their fastest growth in more than 15 years, propelled by semiconductors and AI-related demand. India also accelerated, while Japanese manufacturing weakened as domestic production slowed.

That is generally constructive for global growth, but the composition of the improvement matters. Much of the strength is coming from technology equipment, semiconductors and AI infrastructure rather than a broad-based revival in household demand.

This does not yet look like the old-fashioned global industrial upswing in which demand rises almost everywhere at once. It is narrower and more capital-intensive. That can still be very profitable for companies sitting in the right part of the supply chain, but it leaves the broader recovery unusually dependent on one powerful investment theme.

It also ties the manufacturing outlook more closely to financial conditions. AI spending can continue pulling the industrial cycle forward while capital remains readily available. The higher bond yields climb, however, the more expensive it becomes to build the data centres, power networks and other infrastructure needed to sustain that investment.

Middle Eastern crude exports have recovered, but getting oil to customers remains expensive

The character of the oil shock is changing.

Middle Eastern crude exports recovered to an average of roughly 18.5 million barrels per day by October 1, slightly above the pre-war average of 18 million. Flows through the Strait of Hormuz improved as well. They have not completely normalised, however. Hormuz flows were running at around 14.2 million barrels per day, roughly 80% of pre-war levels.

That has reduced immediate fears of an outright physical shortage. The next problem is getting those barrels where they need to go.

Tanker availability, insurance costs, damaged infrastructure and limited refining capacity continue to keep delivered fuel costs elevated. On some Middle East-to-Asia routes, tanker freight rates have reportedly gone from roughly $30,000 a day to as much as $1.2 million. China's suspension of most fuel exports during October has added another squeeze to Asian gasoline and diesel markets. Attacks on ships and Saudi infrastructure remain an obvious tail risk.

UKOil traded around $101 on Monday and USOil near $90 as emergency stock releases helped take some pressure out of the market. Saudi Arabia has also cut November prices sharply for Asian customers, a sign that it is defending market share while buyers contend with extraordinary transport costs.

The oil shock has not disappeared. It has changed form. The immediate question is becoming less about whether enough crude exists and more about how reliably, and at what cost, it can be transported, refined and delivered to consumers.

The dollar is benefiting from problems elsewhere

The USDOLLAR has now recorded four consecutive weekly gains against the euro.

Its support is no longer simply a story about the Fed. High Treasury yields matter, but so do French fiscal stress and Europe's exposure to imported energy. Those forces have been powerful enough to outweigh the sharp reduction in expectations for an October US rate increase.

Gold provided another useful signal. It fell about 3.4% last week to roughly $4,140 an ounce as a stronger dollar and elevated Treasury yields outweighed demand for geopolitical protection.

Japan offered its own warning from the bond market. Thirty-year government bond yields reached a record high on Monday even as the Nikkei rallied strongly. It is another example of a theme appearing across markets. Equities are still willing to focus on growth and earnings, while government bonds are demanding a much larger premium for inflation, fiscal risk and long-term borrowing.

Risk sentiment is therefore positive, but conditional. Investors welcomed evidence that the Fed can probably pause in October. Sovereign bonds, the euro and gold are telling a less comfortable story about inflation, fiscal sustainability and the global cost of capital.

What matters next

The Fed's September meeting minutes should offer a clearer sense of how strongly policymakers favour another rate increase this year. The next round of US inflation data then becomes particularly important. A soft labour market can give the Fed room to wait, but only if inflation does not force its hand.

Europe bears watching just as closely. The French-German yield spread has become one of the most useful indicators of whether France's problems remain local or start leaking into the broader eurozone. The euro and ECB rate pricing will offer further clues.

For oil traders, headline crude production is no longer enough. Freight rates, insurance costs, diesel inventories, refining capacity and attacks on shipping may matter just as much.

For equities, earnings season is approaching at an awkward moment. AI-related investment now needs to show that profits are arriving quickly enough to justify both rich valuations and a rapidly rising cost of finance.

Final thought

The weak US jobs report has bought markets some time. It has not bought them much comfort. Bond yields remain high, fiscal stress is building in Europe and the energy shock is shifting from production towards the pipes, tankers and refineries that connect supply with demand.

For now, equities are still willing to believe in the soft landing. The more interesting question is whether the bond market eventually gives them permission to.

Sources and References

• reuters.com
• bls.gov
• ec.europa.eu
• bea.gov
• reuters.com