The Fed's higher-for-longer message is continuing to reverberate through the markets, and U.S. 10-year Treasury yields have now climbed above 4.5% for the first time since 2007. That is weighing on risk assets, and as a result, the shift in inflation regime has come back to haunt asset allocators, questioning once again the relevance of the 60-40 portfolios. In this scenario, cash remains king and exposure to the U.S. dollar remains key to hedge the downside risks in portfolios. Higher yields, U.S. resilience and quarter-end flows can continue to support the dollar this week, but risks are seen increasing into October.

This week is light on data but heavy on event risks. Today's consumer confidence data could be key in the U.S. as higher gasoline prices along with high borrowing costs and increasing spending concerns could weigh. August consumer confidence plunged to 106.1 from July's 114 as consumers' assessment of the labor market deteriorated. Entertainment spending should also have started to taper into September and Bloomberg consensus expects U.S. consumer confidence to plunge further to 105.5.

Still, clear deterioration in data may only start to come after all the September data has been reported and there may be some more room for USD strength to sustain. This week's event risks, however, remain key to monitor and could bring some bumps. An adverse outcome could also risk a fast forward to stagflation concerns, and disrupt the USD rally momentarily. 'Three S' risks are lining up – including the student loan repayments that restart in October, the autoworker strikes that are now encompassing the supplier networks, and a potential government shutdown.

Federal student loan repayments are set to restart on October 1 after having been suspended since March 2020, and Moody's estimates that 24 million borrowers will owe an average of $275 per month. This could curtail consumer spending, especially when pandemic-era savings are being exhausted. Meanwhile, the widening United Auto Worker (UAW) strikes against GM and Stellantis risk dampening U.S. industrial output and could result in higher car prices, suggesting stagflation risks. Lastly, a U.S. shutdown could arrive into the coming weekend if Congress fails to provide funding for the fiscal year starting October 1. This could mean thousands of federal workers may be furloughed without pay, again highlighting spending cut risks if the shutdown is prolonged.

While direct economic impact from strikes or shutdown could be limited, sentiment could turn around quickly with all these risks stacking up into the beginning of Q4. Dollar still remains attractive from a safe-haven perspective, given the cratering in yen and Swiss franc, however some consolidation may be likely with net positioning in the dollar also turning to a long after eight weeks. A look at previous shutdown from December 2018-Janauary 2019 showed that dollar declined for four consecutive weeks before gains returned when the resolution was reached. Gold could outperform on safe-haven demand, while sustained gains in oil prices could underpin CAD. If a shutdown is averted, USD bulls could come back stronger.

Eurozone's PMIs were mixed on Friday with German economy seemingly at a turnaround but France slipping further. Overall, Eurozone PMIs remained in contraction, signalling risks for Q3 GDP. Germany's Ifo also showed a marginal improvement, but remained insufficient to spark optimism. Focus is on monthly credit data due Wednesday and flash CPI later this week, and soft numbers could continue to put emphasis on peak ECB rates, bringing EUR downside. Break of key support at 1.0635 in EURUSD has opened the doors to 1.05.

Meanwhile, higher Treasury yields and oil prices continue to push the Japanese yen lower. USDJPY was at fresh 11-month highs, and is testing the 149 handle with verbal intervention remaining lacklustre. Near-term risks is seen at the 150 handle with any real intervention potentially bringing the pair lower towards 145 temporarily but unlikely to reverse the weakness of the yen in any material way.

European markets got off to a poor start to the week yesterday as concerns around sticky inflation, and low growth (stagflation), or recession served to push yields higher, pushing the DAX to its lowest levels since late March, pushing both it and the CAC 40 below the important technical level of the 200-day SMA.

Recent economic data is already flashing warning signs over possible stagnation, especially in Europe while U.S. data is proving to be more resilient.

Worries over the property sector in China didn't help sentiment yesterday after it emerged Chinese property group Evergrande said it was struggling to organise a process to restructure its debt, prompting weakness in basic resources.

The increase in yields manifested itself in German and French 10-year yields, both of which rose to their highest levels in 12 years, with the DAX feeling the pressure along with the CAC 40, while the FTSE100 slipped to a one-week low.

U.S. markets initially opened lower in the face of a similar rise in yields with the S&P500 opening at a 3-month low, as U.S. 10-year yields continued to push to fresh 16-year highs above 4.5%. These initial losses didn't last as U.S. stocks closed higher for the first time in 5 days.

The U.S. dollar also made new highs for the year, rising to its best level since 30th November last year as traders bet that the Federal Reserve will keep rates higher for much longer than its counterparts due to the greater resilience of the U.S. economy.

The focus this week is on the latest inflation figures from Australia, as well as the core PCE Deflator from the U.S., as well as the latest flash CPI numbers for September from France, Germany, Spain as well as the wider EU flash number which is due on Friday. This could show the ECB erred a couple of weeks ago when it tightened the rate hike screw further to a record high.

On the data front today the focus will be on U.S. consumer confidence for September, after the sharp fall from July's 117.00 to August's 106.10. Expectations are for a more modest slowdown to 105.50 on the back of the continued rise in gasoline prices which has taken place since the June lows.

Last night's late rebound in U.S. markets doesn't look set to translate into today's European open with Asia markets also coming under pressure this morning.

Another warning from ratings agency Moody's about the impact of another government shutdown on the U.S. economy, and its credit rating, didn't help the overall mood, while Minneapolis Fed President Neel Kashkari said he expects another Fed rate rise before the end of the year helping to further boost the U.S. dollar as well as yields.

EUR/USD – slid below the 1.0600 level yesterday potentially opening the prospect of further losses towards the March lows at 1 0515. Currently have resistance at 1.0740, which we need to get above to stabilise and minimise the risk of further weakness.

GBP/USD – slipped to the 1.2190 area, and has since rebounded, however the bias remains for a retest of the 1.2000 area. Only a move back above the 1.2430 area and 200-day SMA stabilises and argues for a return to the 1.2600 area.

EUR/GBP – currently have resistance at the 200-day SMA at 0.8720, which is capping the upside. A break here targets the 0.8800 area, however while below the bias remains for a pullback. If we slip below the 0.8660 area, we could see a move back to the 0.8620 area.

USD/JPY – has continued to climb higher towards the 150.00 area with support currently at the lows last week at 147.20/30. Major support currently at the 146.00 area.

The economic slowdown is understandably causing concern among investors. However, while slower growth in China will impact the global economy and financial markets, we think the short-term pain is necessary to avoid bigger problems down the road. China's economy is in the early stages of a long-term transition away from an export-driven, investment-led model toward a more balanced one with more domestic consumption.

During these large transitions, slowing growth is almost inevitable and—from a long-term perspective—desirable.

Part of the growth downshift is simple math. China's economy has roughly tripled in size since the Global Financial Crisis (Display), making it much harder to sustain high growth rates. In fact, trying to boost growth could lead to excessive leverage and, in the case of China, overreliance on sectors with high economic multipliers, such as housing. That would only intensify existing imbalances in China's system, so we believe that slower, but more sustainable growth is a healthier medium-term path.

The other main driver of slower growth is the transition away from a heavier reliance on physical investment (Display) and exports toward a more balanced economic framework. Because so many resources have been devoted to these industries, they have excess capacity today. Trapped capital translates into lower prices as spare capacity is absorbed, and it results in slower growth as wasted, or wasting, resources are eliminated or redeployed.

Meanwhile, sectors with more positive medium-term outlooks continue to thrive, including consumer-facing staples, such as travel and restaurants. Solar and wind power projects are also humming, as are electric vehicle production and other high-tech and green products. It will take time for these industries to replace lost activity in real estate and heavy investment, which is why overall growth is slowing.

How should markets and the rest of the world process China's growth outlook?

We think it's important to avoid focusing too much on the government's growth target—roughly 5% this year. Even if the economy grows at that pace, it won't feel like “good” growth to those outside China. The country's best-performing industries won't likely fuel expansion abroad as much as they have before. It takes massive commodity imports to build roads and bridges; selling movie tickets and restaurant meals doesn't.

All this means that China's economy won't be as big an engine of global growth as it's been in the past. For markets, this evolution may seem disorienting—and is understandably causing jitters among many investors. Slower growth in the world's second most important economy likely means lower overall global growth, even more so because China's growth is becoming more domestically focused.

Much of the anxiety focuses on risks from the transition. Highly levered Chinese firms, particularly in property sectors, will likely feel stress, and policymakers won't be inclined to deliver large-scale support, because it would exacerbate imbalances and delay the transition. Property-developer defaults could become severe enough to imperil the banking sector or local government finances—but that's not our base case. The transmission mechanism from China's financial system to the world is limited in direct terms, though turmoil in China could rattle sentiment elsewhere.

To sum things up, we share the view that China's economy is slowing, and that slower growth will likely last as the economy transitions. There are also financial-market risks associated with that slowdown. But in our view, the “cure” to that problem—piling more debt and leverage onto the economy and property sector—would be worse than the ailment.

We think China's policymakers feel the same way, so we expect targeted, gradual stimulus to manage the slowdown, not a “big bang” stimulus to push growth into a faster trajectory.

Donald trump's campaign for re-election is dogged with legal woes. The former president faces the prospect of four criminal trials on felony charges, which will overlap with the Republican primary season and the general-election campaign. But another type of legal trouble could further complicate his return to the White House.

America's constitution—which Mr Trump swore to uphold on January 20th 2017—includes a provision barring people who have taken such an oath from holding federal office if they have “engaged in insurrection or rebellion” against the country or “given aid or comfort to the enemies thereof”. This language, found in Section 3 of the 14th Amendment, was ratified after the civil war to prevent former Confederate rebels from having a hand in running the country they had tried to saw in half. The disqualification clause has seen something of a renaissance. A year ago, Couy Griffin, then a county commissioner in New Mexico, was removed from office by a state judge for engaging in insurrection at the Capitol on January 6th. But could this constitutional provision really thwart Mr Trump's quest for a second presidential term?

The idea gained prominence in August when two respected legal scholars from the right—Will Baude of the University of Chicago and Michael Stokes Paulsen of the University of St Thomas in Minneapolis—answered this question with an emphatic “yes”. In a 126-page article, to be published next year in the University of Pennsylvania Law Review, they contend that Section 3 “disqualifies” Mr Trump “and potentially many others” who played a role in “the attempted overthrow of the 2020 presidential election”. J. Michael Luttig, a judge appointed by George W. Bush, and Laurence Tribe, a law professor at Harvard University, endorsed the proposal.

But other scholars on the left and right have voiced doubts that Mr Trump's contributions to the January 6th riot automatically bar him from office. Some question whether the former president can be said to have engaged in an insurrection. Many point to a precedent from 1869 in which Salmon Chase, the chief justice, ruled that Section 3 could only be enforced by Congress. Messrs Baude and Paulsen disagree. They argue that Section 3 is “self-enforcing”. Not having engaged in insurrection or not lending support to America's enemies, they say, is a requirement for public office in the same way that the presidential minimum age of 35 is—and secretaries of state in the 50 states are therefore empowered to remove Mr Trump's name from the ballot for the upcoming election.

Lawsuits based on this theory are springing up. Eight voters in Minnesota filed one this month. In Colorado, Citizens for Responsibility and Ethics in Washington, the same watchdog that successfully sued Mr Griffin in New Mexico last year, is suing on behalf of six voters in the state. The organisation argues that Mr Trump is responsible for “recruiting, inciting and encouraging a violent mob that attacked the Capitol” and should not be listed on Colorado's Republican primary ballot. Similar challenges were brought against Marjorie Taylor Greene and Madison Cawthorn, respectively current and former members of the House of Representatives, but neither resulted in their disqualification. If courts rule that Mr Trump is ineligible to run for office, and secretaries of state begin removing his name from ballots, quick appeals would ensue. The issue would probably reach the Supreme Court, where the justices may want to provide clarity before the first primary votes are cast in January. The surge in attention to the disqualification clause will probably remain mostly academic: it would be remarkable for a majority of the court to subject a presidential election to a largely untested legal theory.

1. Fed's Goolsbee: Rates will have to stay higher for longer.

2. Japan will compile a new economic stimulus package.

3. ECB Lagarde: No rate cuts are being considered.

4. U.S. 10-year bond yield hits a 16-year high and the long-treasury bond ETF sinks.

The risk of inflation staying higher than the Fed's target is the bigger risk, Chicago Fed President Austan Goolsbee said on Monday, It feels like rates will have to stay higher for longer than markets had expected, he added. The Fed would need to "play by ear" whether any further rate increases are needed.

The debate over the current phase of Fed policy will "stop being how much more are they going to raise, and transform into well how long do we need to hold rates" at the peak level.

Although the Federal Reserve has been raising interest rates, the United States is still possible to avoid a recession.

At present, FOMC hawkish officials not only implied there would be one more rate hike in the year but also expected rates to stay high for longer. They lowered their forecast for next year's interest rate cuts to 50 basis points from 100 basis points.

Japanese Prime Minister Fumio Kishida on Monday unveiled the main elements of a new economic stimulus package to be formulated next month. The package will help ease the impact of rising prices on households and raise wages.

Kishida will instruct his Cabinet on Tuesday to put together the package and quickly set up an extra budget to fund it.

The package will include measures to protect people from cost-push inflation, support sustainable wage and income growth, promote domestic investment to spur economic growth, carry out reforms to overcome population decline and encourage infrastructure investment, etc.

With the new economic measures, Kishida pledged to shift Japan's economy, which has tended to focus on cost-cutting, away from such practices. Kishida also warned investors who try to sell the yen, by saying that he was closely monitoring exchange rate movements with a high sense of urgency.

Our future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary, said European Central Bank (ECB) President Christine Lagarde on Monday. There is little likelihood of easing monetary policy in the short term, and the prospect of a rate cut is not even being considered at the moment.

The economic outlook for the euro area is deteriorating, with economic activity generally stagnating in the first half of 2023. Recent indicators pointed to further weakness in the third quarter. Lower demand for exports in the euro area and a tighter financing environment are dampening growth. The service sector is also weakening and job creation in the service sector is slowing.

As the market officially enters the final week of the third quarter this week, the sharp decline in U.S. Treasuries over the past few months continues. 10-year bond yield rose 10.4 basis points overnight to 4.539%, the highest since October 2007, and the 30-year yield rose as much as 13 basis points to 4.66%, a level not seen since April 2011, as markets anticipated the Fed to keep interest rates high, and the supply of new bonds was expected to keep rising as the federal government struggles with growing deficits.

Additionally, the $39 billion iShares 20+ Year Treasury Bond ETF has lost 48% from its all-time high in 2020 and is trading at its lowest point since 2011.

UTC+8 15:00 ECB Governing Council member Simkus speaks

UTC+8 16:00 ECB Governing Council member Kazimir delivers a speech

UTC+8 22:00 U.S. New Home Sales MoM (Aug)

UTC+8 00:30 Next Day: ECB Governing Council member Holzmann speaks

TBD U.S. House of Representatives to vote on temporary spending bills

In investment management, past performance is no guarantee of future returns. In economics, we've seen many predictions of a U.S. recession that so far, at least, have not materialized. Investors should take note that the past performance of a key economic tenet — that a recession follows an inverted yield curve — may no longer be as reliable today as it once was.

Let's first look back at the pace of inflation. When it started to ramp higher in 2021, many economists, as well as the Federal Reserve, dismissed the pattern as “transitory.” But by March 2022, the Fed understood that the new inflation pattern was serious and commenced raising short-term rates. That November, the Fed's guidance hardened, with Fed Chair Jerome Powell stating that “reducing inflation is likely to require a sustained period of below-trend growth and some softening of labor market conditions.”

At this point, the U.S. Treasury two-year yield was higher than the 10-year yield, creating an inverted yield curve, and rates were rising at the most rapid pace since the early 1980s. For the vast majority of economists, these facts were strong signals to forecast rising unemployment and a U.S. recession in 2023.

Yet as the fourth quarter of 2023 approaches, signs of a U.S. recession are not so clear. The consensus of many economists has shifted away from the recession forecast, although some have merely pushed the timing into 2024, citing lags in monetary policy, or shifted to words like “mild” or “soft landing” to describe any possible future downturn.

Why the shift? Regardless of whether we eventually end up in a recession, the key here is how an inverted yield curve may not mean the same as it did 20 years ago. Has our economy become far more resilient in the face of restrictive interest rate policies?

Let's look at what history shows us. Back in the 1950s, '60s and '70s, manufacturing was the engine of the U.S. economy, with the purchase of durable goods often facilitated by credit. If one wanted to buy a house, a 30-year fixed-rate mortgage was the only choice. Moreover, that choice was typically provided by a savings and loan institution that borrowed short-term from savers and lent long-term for houses or medium-term for cars.

Taking interest-rate risk and surviving short periods of inverted yield curves was the savings and loan business model, since efficient rate hedging vehicles were not available. When the Fed hiked interest rates, lending slowed for houses and cars, the economy slumped, and unemployment eventually started to rise.

Fast forward to today. The U.S. is a service-sector economy, and most service purchases do not involve a loan or credit. Mortgages come in all shapes, sizes, terms and maturities, and are originated by specialized brokers that package and sell the mortgages to investors who want to hold this risk. For financial institutions, the ability to hedge and manage interest-rate risk is further supported by deep markets in swaps, futures and options.

Higher rates, which alter the time value of money, still have a profound impact on asset markets, from equities to fixed income. But the impact of those rates on the real economy is much less clear as the U.S. economy evolves. Yet, most econometric models still rely on historic relationships, which don't take into account recent structural changes impacting interest-rate sensitivity.

Moreover, the last three serious recessions all required something big and systematic to break. In 1991, it was the savings and loan industry and the housing market, brought on by tighter credit conditions. In 2008, it was the financial crisis brought on by risk taking in subprime housing. In 2020, it was the Covid-19 pandemic, which had nothing to do with rates.

This year, the failure of a few niche regional banks could have been the trigger for contagion and a serious banking system collapse. That was not the case because regulators quickly backstopped the system. Additionally, most banks had hedged their positions.

Could it be that a less interest-rate sensitive economy and a regulatory network committed to preventing systemic financial-system breakdowns has reduced the power of an inverted yield curve to forecast a recession? Time will tell. Until then, investors should be cautious about relying on historical parallels as they prepare their portfolios for the risks ahead.