Soaring oil prices coupled with inflationary pressures led to a double whammy for Asian stocks and bonds, with Japanese stocks plunging 3% and Japanese bond yields continuing to rise.

Soaring oil prices coupled with inflationary pressures led to a double whammy for Asian stocks and bonds, with Japanese stocks plunging 3% and Japanese bond yields continuing to rise.

Oil prices breaking through the $100 mark and the US producer price index rising more than expected have combined to push Asian markets into a double whammy of falling stocks and bonds.

Asian stock markets fell across the board in early trading on Friday, with the MSCI Asia Pacific Index down 1.3%, led by declines in Japan and South Korea. The Nikkei 225 index once extended its losses to 3%, while the Korea Composite Stock Price Index (Kospi) fell 2.7%, with Samsung Electronics and SK Hynix dropping 3.8% and 4% respectively.

The bond market also came under pressure, with yields on Japanese and Australian government bonds rising sharply in line with those on US Treasuries. The yield on three-year Australian government bonds jumped as much as 20 basis points to 5.05% in a single day, hitting a multi-year high.

The immediate trigger for this sell-off came from the US market. The yield on the 10-year US Treasury note hit 4.97%, the highest level since October 2023; overnight, the Dow Jones Industrial Average fell more than 300 points, while the S&P 500 and Nasdaq Composite both fell by about 0.6% to 0.7%, marking the fourth consecutive trading day of declines for all three major indices. The market is now focused on the US August CPI data to be released on Friday, which will directly influence the Federal Reserve's interest rate decision on September 16.

Oil prices break $100, supply concerns ignite market.

The core driver of this round of market turmoil comes from the energy market. Brent crude oil climbed to nearly $110 a barrel during US trading hours, while WTI crude oil rose a further 0.6% to $103.05 a barrel on Friday, both reaching their highest settlement prices since May 19 this year.

The surge in oil prices is driven by the ongoing tensions in the Strait of Hormuz. The US-Iran conflict has lasted seven months, with escalating attacks on ships passing through this crucial waterway, pushing up oil, natural gas, and diesel prices. Markets are concerned that energy costs will be further passed on to inflation. Iran has stated it will not back down in the face of a US naval blockade and has threatened to escalate its retaliation if the US continues to attack its territory.

"Rising oil prices will be a major concern ahead of the midterm elections," said Warren Patterson, head of commodities strategy at ING. "For us to see oil prices rise significantly further, the recent escalation of tensions would need to actually disrupt oil flow in the Strait of Hormuz."

PPI exceeded expectations, fueling bets on a Fed rate hike.

The combined effects of energy shocks and inflation data have further strengthened market expectations for a Federal Reserve rate hike. The U.S. Producer Price Index (PPI) rose 0.4% month-over-month in August, the largest monthly increase since May, and rose 5.4% year-over-year.

Following the data release, the interest rate swap market priced in a probability of a Fed rate hike next week to approximately 70%, fully incorporating expectations of an October rate hike. European Central Bank President Christine Lagarde also signaled a hawkish stance, stating that inflation risks in the Eurozone extend into 2027, further fueling concerns about a tightening of global monetary policy.

Joe Brusuelas, chief economist at RSM US LLP, stated, "The overheated US PPI data, coupled with Christine Lagarde's hawkish remarks, points to a reality—a new round of interest rate hikes by global central banks may already be underway, which offers no support for risk assets in the current or short term."

The bond market was under pressure as US Treasury repurchase operations fell short of expectations.

The selling pressure in the bond market stemmed not only from inflation expectations, but also from disappointing repurchase operations by the U.S. Treasury. On Thursday, the first expanded Treasury repurchase operation led by Treasury Secretary Scott Bessent saw the actual repurchase volume of 10- to 20-year Treasury bonds fall short of investor expectations, causing the entire U.S. Treasury yield curve to rise.

Asian bond markets subsequently fell. The yield on Japan's 10-year government bonds rose 5.8 basis points to 2.981%, and the yield on 20-year bonds rose 5.5 basis points to 3.805%; the yield on Australia's 10-year government bonds rose 12 basis points to 5.37%; and the yield on New Zealand's two-year government bonds also climbed 21 basis points.

Wolfe Research chief economist Stephanie Roth noted, "Both yields and oil prices may need to fall for the stock market to stabilize." She stated that if Friday's CPI data is "significantly lower than expected," it could provide the market with some breathing room.

CPI becomes a key variable; the market awaits direction.

The market's primary focus is on Friday's release of the August CPI data. According to a Dow Jones survey, economists expect the figure to rise 0.4% month-over-month and 3.4% year-over-year.

Christopher Hodge, chief U.S. economist at Natixis CIB Americas, said, "If the data meets expectations, it will be the fourth consecutive month of encouraging inflation readings, easing pressure on the Fed to raise rates in September. If inflation is higher than expected, we expect the Fed to announce a rate hike at its meeting next week."

Market sentiment is expected to remain cautious ahead of the release of CPI data. Whether the simultaneous decline in both stocks and bonds can be reversed depends on whether the inflation data can dispel concerns about the transmission of rising oil prices to broader price pressures.

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