Market Week: Oil Drives Prices Higher – Central Banks Are Following Suit

The war in the Middle East is now feeding through to inflation via oil, diesel and transport costs. At the same time, China and parts of the digital economy are growing more strongly than expected. This leaves stock markets facing an unusual problem: it is not economic weakness but the cost of economic resilience that is driving prices.

Just two weeks ago, the DAX reached a new all-time high. Since then, the picture has changed considerably.

The German benchmark index ended Friday 0.82 percent higher at 25,568.56 points. Over the week, however, it lost 1.83 percent and is now almost 4 percent below its record from August 28. Europe’s STOXX 600 also gained 0.5 percent on Friday but recorded its sharpest weekly decline since early July. On Wall Street, the S&P 500, Nasdaq and Dow all rose strongly on Friday – yet over the week, the S&P 500 lost 0.8 percent and the Nasdaq 0.7 percent.

The pattern is similar to the previous week. But the economic story behind it has now become clearer. What began as a geopolitical oil price shock is reaching the inflation data. The inflation data are reaching the central banks. And their response is reaching virtually every asset class through rising bond yields.

On Thursday, the European Central Bank raised interest rates.

On Friday, following the release of US consumer price data, the probability priced into markets of a Federal Reserve rate hike in the coming week rose to almost 90 percent.

This has turned a crisis in the energy market into a global financial market issue.

The ECB takes the first step

On Thursday, the European Central Bank raised its deposit rate by 25 basis points to 2.50 percent. It was already the second rate increase this year. The main reason lies in energy prices.

Inflation in the eurozone rose above 3 percent in August and is therefore once again clearly above the ECB’s 2 percent target. For Germany, harmonised inflation was confirmed at 2.9 percent on Thursday, up from 2.8 percent in July.

The situation is more nuanced than headline inflation suggests. Core inflation and wage pressures are developing much more calmly. So far, there are no clear signs that the energy price shock has already developed into a broad wage-price spiral.

The reason why the ECB is proceeding cautiously.

It must prevent higher oil and gas prices from becoming permanently embedded in other prices – without unnecessarily choking off an already fragile European economy with excessively high interest rates.

The new projections illustrate this dilemma clearly.

The ECB raised its growth forecast for the eurozone in 2026 slightly from 0.8 to 0.9 percent and for 2027 from 1.2 to 1.4 percent. At the same time, it now expects average inflation of 2.5 percent in 2027 instead of the previous 2.3 percent.

• The economy is therefore growing somewhat more strongly.
• But inflation also remains higher.
• For monetary policy, that is not a comfortable combination.

It is precisely the resilient economy that makes higher interest rates possible

This continues a pattern that has occupied stock markets for weeks. Despite war, an energy price shock and high financing costs, the global economy is not collapsing. That gives central banks greater scope to fight inflation more aggressively.

In the United States, this logic became particularly clear this week.

On Thursday, the Labor Department reported that producer prices rose by 0.4 percent in August. Compared with the previous year, producer prices were as much as 5.4 percent higher. Energy prices rose particularly sharply, increasing by 4.2 percent in a single month.

The consumer price index followed on Friday. Consumer prices rose by 0.4 percent compared with July and by 3.4 percent year on year. Gasoline became 3.9 percent more expensive within a month, while diesel rose even more sharply. Core inflation also increased by 0.3 percent.

The energy shock is therefore becoming increasingly visible. And the market reacted immediately.

The probability of a Federal Reserve rate increase in the coming week rose to around 87 to 90 percent in futures markets.

Just a few months ago, investors were discussing when the Fed might cut interest rates. Now the question is how far they may have to rise again.

Oil remains the starting point of the chain

A look at the oil market is enough to explain why.

Brent crude ended Friday lower at 104.61 dollars per barrel. Over the week, however, the North Sea benchmark still gained more than 8 percent. US West Texas Intermediate closed at 100.05 dollars.

Prices had risen considerably higher during the week. The reason remains the supply situation in the Middle East.

The war and attacks on tankers, pipelines and other energy infrastructure have significantly disrupted oil supplies. According to the International Energy Agency, global oil production is therefore expected to fall by 5.7 million barrels per day in 2026 – around 6 percent. Saudi production has fallen to roughly 6 million barrels per day, its lowest level in more than 30 years.

The situation in refined products is in some cases even more dramatic. In the United States, diesel prices reached record levels of more than 6 dollars per gallon. This makes clear why central banks cannot simply treat the oil price surge as a temporary geopolitical event.

• More expensive diesel makes trucking more expensive.
• More expensive fuel makes air travel more expensive.
• More expensive transport makes goods more expensive.

And when companies pass these costs on, an oil price shock turns into broader inflation.

Even transporting the oil is becoming an inflation factor

A second problem has now emerged. It is not only the oil itself that is becoming more expensive. Transporting it is also costing considerably more.

Following the latest attacks on ships around the Strait of Hormuz, freight rates for large oil tankers have risen to record levels. For a Very Large Crude Carrier on the route from the Gulf of Oman to China, freight costs now amount to around 11.50 dollars per barrel transported.

The situation deteriorated further after the Houthis reached the strategically located island of Perim in the Bab al-Mandab Strait.

This means that two of the most important sea routes for global energy trade are under pressure at the same time: the Strait of Hormuz and the connection between the Red Sea and the Gulf of Aden.

For the global economy, this makes a difference:

A short-term rise in oil prices can reverse. But if insurance, freight and rerouting costs also remain permanently elevated, a commodity shock turns into a logistical cost shock.

Stock markets are increasingly beginning to price in this second-round effect.

Bond markets are carrying the real stress

This repricing is therefore most visible not in equities, but in government bonds.

Rising inflation and interest rate expectations have pushed yields higher worldwide. In the United States, the yield on ten-year government bonds temporarily approached the 5 percent mark. European bonds also came under pressure following the ECB decision.

The energy shock therefore has a double effect. It directly raises costs for companies and consumers. And through higher interest rates, it also makes financing more expensive. This second effect is particularly important for stock markets.

Government bond yields form the basis for countless other financing costs – from corporate bonds and mortgages to the valuation of future corporate earnings.

In the United States, the average rate on 30-year mortgages has now risen to 6.76 percent, its highest level in more than 14 months.

The interest rate shock has therefore long since moved beyond financial markets. It is reaching the real economy.

Germany is feeling both sides at once

For Germany, this development is particularly uncomfortable.

The latest data confirm that the economic recovery remains fragile. German industrial production unexpectedly fell by 1.1 percent in July compared with the previous month. Automotive production and other energy-intensive sectors were among the main drags. This puts some of the more positive sentiment indicators of recent weeks into perspective.

Germany remains in an unusual transitional phase. Orders and business expectations have improved in some areas. At the same time, production, investment and parts of the labour market remain weak. At this stage, higher energy and financing costs are once again hitting industry.

That explains part of the weaker performance of the DAX. Since its record on August 28, the index has lost almost 4 percent. The decline is therefore not solely a reaction to weak German economic data. It is also a reassessment of the conditions under which a German recovery would have to take place at all.

China, by contrast, shows how strong global demand still is

A completely different signal came from China this week.

Chinese exports rose by 25 percent in the first eight months of the year. Imports increased by as much as 28.2 percent. The trade surplus reached 119.09 billion dollars. Trade in high-tech products was particularly strong.

Chinese exports of these goods rose by 42.9 percent. Semiconductors and vehicles were among the main drivers.

This matters for global stock markets for two reasons:

First, it shows that international demand is far from collapsing despite high interest rates and geopolitical tensions.

Second, such data reduce the pressure on Beijing to support its economy with even more aggressive monetary policy measures.

Here too, the same paradoxical logic applies:

Stronger economic data reduce the likelihood of cheap money.

AI remains a growth engine – and a capital drain

The same tension can now be seen among the major technology companies.

Oracle reported strong figures this week. Its backlog in the cloud business initially generated particular enthusiasm. Total remaining performance obligations increased by another 26 billion dollars to 664 billion dollars. Yet the stock was unable to hold on to its initial gains and closed Friday around 2 percent lower.

The reason lies in the capital requirements. Oracle is investing billions in data centres and AI infrastructure and plans to raise around 40 billion dollars through debt and equity financing in this fiscal year alone. Free cash flow most recently stood at minus 5.4 billion dollars.

Oracle is therefore almost a textbook example of the new problem facing the AI boom. Demand is real. Growth is real. But the infrastructure required to support it is enormously expensive.

The higher interest rates rise, the more critically investors ask when gigantic investments will actually translate into corresponding cash flow.

That increasingly distinguishes the current phase from the first wave of AI euphoria. Back then, the prospect of growth was enough. Today, the financing of that growth is part of the calculation.

Adobe shows the other side of AI competition

Adobe presented a similar picture this week.

The software group generated 6.76 billion dollars in revenue in the third quarter, exceeding analysts’ expectations. Recurring revenue from AI-oriented products has more than doubled compared with the previous year. Nevertheless, the stock fell by around 2 percent in after-hours trading.

The outlook for the fourth quarter fell slightly short of expectations. This is not only about the broader interest rate issue. Adobe is also facing growing competitive pressure from new AI-based design offerings.

Artificial intelligence is therefore changing the stock market on two levels. It is creating new areas of growth. And it is threatening established business models.

The winners of the AI boom will therefore not automatically be those companies that are already major software or technology groups today.

Gold falls despite war and inflation

Against this backdrop, the performance of gold is particularly interesting. In theory, gold currently has almost every classic argument in its favour.

• War.
• High inflation.
• Uncertainty over public finances.
• Geopolitical risks.

Even so, the precious metal lost around 1.5 percent over the week, marking its third consecutive weekly decline. On Friday, the spot price recovered to around 4,360 dollars per ounce.

Once again, the reason lies in interest rates. Gold generates no running income. When yields on safe government bonds rise, the opportunity cost of holding gold therefore increases. That makes the current move significant.

The classic safe haven is being supported by geopolitical risks. At the same time, those very same geopolitical risks are weakening gold because they push up oil prices, inflation and therefore interest rates. Even gold cannot escape the monetary policy chain of cause and effect at present.

Above it all, a second interest rate problem is growing

Alongside inflation and energy prices, another factor remains in the background: US government debt.

The US budget deficit had already reached 1.97 trillion dollars in the first eleven months of the current fiscal year, exceeding the entire previous year’s deficit of 1.775 trillion dollars.

Of particular relevance to financial markets are interest costs. Government interest expenditure since the beginning of the fiscal year is already 143 billion dollars, or 13 percent, higher than in the corresponding period of the previous year.

This creates a self-reinforcing mechanism:

• Higher interest rates make government financing more expensive.
• The government has to issue more bonds.
• The additional supply may in turn require higher yields.
• Rising government bond yields then increase financing costs for the rest of the economy.

The market is therefore not only wrestling with the question of how high central banks will set their policy rates. It is increasingly asking what price investors will demand simply to lend money to governments over the long term.

The common story of this week is not on the stock exchange

The individual headlines could hardly look more different.

• The ECB raises its policy rate.
• US consumer prices rise.
• China exports 25 percent more.
• Oracle invests billions in AI.
• Gold falls.
• The DAX declines.
• Oil tankers become more expensive than ever.
• Yet economically, these developments belong together.
• The global economy has so far proved remarkably resilient.
• China is exporting strongly.
• Europe’s economy is growing despite the energy crisis.
• AI investment remains enormous.
• The US economy is holding up.

This gives central banks room to continue fighting inflation. At the same time, the geopolitical situation is making energy and transport more expensive again.

Three forces are therefore colliding:

1. a resilient economy,
2. a new supply shock,
3. and tighter monetary policy.

For equities, this combination is more challenging than a conventional recession scenario. In a recession, central banks can eventually cut interest rates. In a resilient economy with high inflation, they cannot.

The central question for stock markets is therefore no longer:

When will the next rate cut come?

But rather:

How far do interest rates have to rise before the economy actually weakens?

What matters in the coming week

The answer could move a little closer in the coming week.

On Wednesday, September 16, the Federal Reserve will decide on monetary policy. Following Friday’s inflation data, futures markets are now pricing in a rate increase with a probability of around 87 percent.

At least as important as the rate decision itself will be the Fed’s new projections and the so-called dot plot. They show what level of interest rates members of the Federal Open Market Committee expect in the years ahead.

The Bank of England follows on Thursday.

And on Friday, attention turns to Japan.

A Reuters poll expects the Bank of Japan to raise its policy rate from 1.00 to 1.25 percent. That would mean that within just eight days, three of the world’s most important central banks could tighten monetary policy. This deserves particular attention.

The yield on ten-year Japanese government bonds had already risen above 3 percent at the beginning of September for the first time since 1996. Rising Japanese interest rates can alter capital flows worldwide because Japanese investors hold enormous amounts of wealth abroad.

The Federal Reserve will also release new US industrial production data on Friday.

And then there remains the factor that no central bank can control.

The Middle East.

Hopes for diplomatic talks on reopening or normalising traffic through the Strait of Hormuz brought oil prices significantly down from their weekly highs on Friday.

If this really does lead to an easing of tensions, it could relieve several markets at the same time:

Oil. Inflation. Bonds. And therefore equities.

If it fails, the chain of cause and effect seen this week is likely to continue. Because at the moment, the most important stock market story often begins not in Frankfurt or New York.

But on a waterway between Iran and Oman.

Stefanie S. Klief