U.S., Japan and Europe Face Rate-Hike Risks as Middle East Tensions Flash Volatility Warning for Global Markets

Global financial markets could see volatility rise sharply through year-end as the risk of additional rate hikes in major economies combines with fiscal strains and higher oil prices driven by the war in the Middle East.

Bloomberg reported on September 7 that U.S. investors were returning from the Labor Day holiday as bond and currency markets prepared for a string of monetary policy decisions from the Federal Reserve, the European Central Bank and the Bank of Japan. Market volatility remained unusually subdued last month despite reports of government intervention to defend the yen and stabilize U.S. Treasury yields. That backdrop could shift from September as major policy events crowd the calendar.

The ECB is expected to raise its benchmark rate by 25 basis points at its next policy meeting. The Fed is scheduled to announce its rate decision on September 16, with a BOJ meeting to follow. Markets are also weighing the possibility that the BOJ could raise rates by 25 basis points this month because of inflation risks. If the Fed delivers a relatively dovish signal, yen strength could accelerate and the unwind of yen carry trades could gather pace. The market is estimated to still hold about $103 billion in bets on yen weakness.

Fiscal problems in major economies are also adding to bond-market jitters. In the U.K., rising gilt yields and high inflation are rapidly eroding the government's fiscal room. France is also under pressure, with a budget deficit above 5% of gross domestic product and political uncertainty weighing on sentiment. In the U.S., national debt has reached $40 trillion, and uncertainty over fiscal policy could widen ahead of the November midterm elections.

Large-scale corporate fundraising is also poised to weigh on bond markets. In the U.S., borrowing for artificial intelligence infrastructure investment has surged, and September issuance of investment-grade corporate bonds is forecast at about $215 billion. Some Wall Street estimates put the total as high as $250 billion. If corporate bond issuance rises alongside Treasury supply, competition for market liquidity could intensify.

Geopolitical risks remain another variable. Brent crude has climbed close to $100 a barrel as tensions between the U.S. and Iran intensify, fueling concern that global inflation could reaccelerate. Tariff friction between the U.S. and Canada, along with renewed U.S.-China trade tensions, could further increase volatility across stocks, bonds and currencies.

Carol Lye, a portfolio manager at Brandywine Global Investment Management, said volatility across asset markets could rise and risk assets could weaken if an oil shock coincides with Fed and BOJ tightening, political uncertainty and AI-related credit concerns.