In the US, flash PMI figures for September showed activity expanding at the fastest pace in more than five years. New orders grew at the fastest pace since April 2022, while manufacturing hiring was the strongest since February 2021.

Massive AI investment and resilient consumer spending outweighed energy-price-led worries, though supplier delivery times stretched, according to the same data, while input costs remained elevated due to high energy prices and supply-chain pressures.

In other words, economic activity expanded strongly while price pressures remained elevated. That’s the perfect combination for fuelling further rate-hike expectations. The US 2-year yield – which best captures Federal Reserve (Fed) rate expectations – spiked past 4.94%, the highest since June 2024; the 5-year spiked past 5% for the first time since 2007, also hammered by a weak 5-year bond auction; the 10-year yield spiked past 5.10%; and the 30-year yield returned above 5.40%.

The bond selloff spilled over to Japanese bonds. The Japanese 10-year JGB returned from holiday with a jump above 3%. Equities are hammered, of course, with the US Nasdaq 100 taking the biggest hit after hitting a record high the day before.

If it’s any relief, crude oil is down this morning, retracing some of yesterday’s rebound. US diesel futures fell sharply too, though the relief at the pump was negligible — retail diesel remains essentially at record highs. And the surprisingly strong US data – and hawkish Fed expectations – will likely keep the market mood subdued.

Beyond the US, the Australian and Japanese PMI numbers looked soft, especially in Australia, where the manufacturing PMI fell below the 50 mark – hinting at contraction. In Europe, however, the picture was surprisingly strong as well. Here, the improvement was driven particularly by services, which expanded faster than expected, while manufacturing remained firmly in expansion territory despite rising fears over elevated energy prices.

Overall, the data suggested that the euro-area economy is holding up better than feared despite elevated energy costs and tighter financial conditions. No one knows for how long, but what is clear is that strong data gives the European Central Bank (ECB) room for further policy tightening as well, to fight energy-led inflation. The latter could’ve put a floor under the EURUSD’s slide, but the US PMI numbers – and hawkish Fed expectations – weigh more heavily.

This morning, the US dollar is stronger against most majors. The dollar index’s appreciation is gathering momentum above the 100 mark as hawkish Fed expectations and elevated US yields continue to support the greenback. With such strong data, the case has strengthened that the Fed’s latest hike could mark the beginning of a new tightening cycle in US monetary policy – and that’s positive for the greenback.

The EURUSD has slipped below the 1.14 mark. The pair is approaching an important technical level: 1.1350, the major 38.2% Fibonacci retracement since Donald Trump’s return to the White House, hence a critical support level for the so-called debasement trade.

The same is true for Cable: the pair is also approaching its own 38.2% retracement of the 2025–2026 rally. A further appreciation of the US dollar will therefore challenge the ‘debasement trade’ in the short run, without, however, justifying a sustainable return to the US dollar in the longer run. Appetite for the US dollar and US Treasuries has weakened structurally.

On the one hand, US yields above 5% are appealing for locking in returns over a 5-, 10- or 30-year horizon. The latter could encourage capital flows from equities to sovereign bonds.

On the other hand, major foreign buyers, such as governments and central banks, are less sensitive to price changes than private investors. Their decisions are driven by reserve management, liquidity and safety considerations, and concerns over rising US debt, inflation expectations and geopolitical uncertainty could continue to weigh on their appetite for US Treasuries.

As we discussed earlier this week, gold and Bitcoin are both down on a stronger US dollar – the reverse debasement trade. Bitcoin could retreat further as the dollar rebounds and technology stocks pull back.

Gold will also remain under pressure from a stronger dollar and stronger US yields, which increase the opportunity cost of holding non-interest-bearing gold. But the yellow metal could find support in the medium to long run from strong institutional appetite.

Gold’s latest behaviour suggests that it has become much less sensitive to changes in the US 10-year yield since 2022 than it used to be. Gold gained over the longer run as US yields rose, and it gained as real yields turned positive, suggesting that many investors looked past the opportunity cost of not holding US Treasuries.

PS: 2022 marks Russia’s invasion of Ukraine and the freezing of Russian assets... it also marks the beginning of a stronger shift by some reserve managers toward alternative reserve assets such as gold. Uh huh...

Coming back to FX, the divergence between US strength and softer Australian and Japanese PMIs is reflected in a softer AUDUSD, now testing the 200-DMA to the downside, while USDJPY is moving in the opposite direction this morning.

But its upside is being challenged by Japanese Finance Minister Satsuki Katayama’s warning that the principles established during the July Japan–US coordinated FX intervention “remain alive”, reminding markets that joint intervention remains an option – and any intervention could rapidly wash out crowded short-yen positions. Looking at the recent past, however, the USDJPY remains below the levels that triggered the July intervention.

Last but not least, there is news that the US and China have agreed to extend their trade truce for another two months. Trump and Xi will meet today. I don’t expect any major shake-up from that meeting.

The two leaders’ willingness to fight the AI race – and win – could eventually counterweigh AI experts’ warnings that the development of increasingly powerful models should slow. That, combined with the present Muse AI optimism, could encourage technology investors to look for dip-buying opportunities.