Energy, Finance, and Global Capital Intertwined: The Federal Reserve's Policy Space Faces Multiple Constraints

On September 9, the escalating situation in the Middle East pushed Brent crude oil prices close to $100 per barrel, amplifying market concerns over energy supply and inflation. If energy prices remain high, they will transmit through transportation, manufacturing, and refined oil prices to core inflation, complicating the policy environment for the Federal Reserve. This also raises the significance of this week's CPI and PPI reports, as the market is not only focused on whether inflation will cool down but also on whether energy prices will form new inflationary stickiness.

U.S. Treasuries are facing another layer of structural pressure. The U.S. fiscal deficit, $40 trillion in debt, and financing demands from AI companies continue to push up long-term funding costs, drawing attention to the upcoming announcement of the Treasury's bond buyback scale. However, buybacks mainly improve the supply-demand structure for specific maturities and are unlikely to change the massive fiscal deficit and long-term financing needs, thus their impact on long-term yields remains limited. In other words, while buybacks can enhance market liquidity, they cannot resolve fiscal supply issues.

Japan is adding uncertainty to global capital allocation. Yen interventions and a decline in overseas securities holdings have raised market concerns about whether Japan will sell some U.S. Treasuries; if the yen continues to appreciate, the approximately $23.5 billion short position in yen may also face a buyback pressure. If the Bank of Japan further raises interest rates and increases incentives for capital repatriation, global bond allocations may be readjusted, further affecting demand for long-term U.S. Treasuries.

Regarding the Russia-Ukraine situation, diplomatic processes between the U.S. and Russia are still ongoing, but military actions have not ceased, and Ukraine continues to bolster its air defense capabilities, indicating that geopolitical risks have not been alleviated. Overall, the Middle East affects energy and inflation, Russia-Ukraine impacts supply chains and energy security, Japan influences global capital allocation, while the U.S. manages financial conditions through interest rates and debt management. Therefore, what is truly worth observing in the CPI, PPI, and U.S. bond buyback scale is whether the high-interest-rate environment will loosen due to cooling inflation or be extended by the interplay of energy, fiscal, and global capital supply and demand.

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