This week has been exceptionally eventful for the markets. Analysis suggests the flattening slope of short-term rates appears more like a policy fine-tuning than the start of a new rate-hike cycle. However, long-term rates hold underlying upward momentum, shadowed by persistent fiscal deficit concerns. While the base case remains the FOMC holding steady, a 25 basis point hike is not off the table if escalating tensions in the Strait of Hormuz compound existing inflationary pressures. When negative events cluster, their combined probability often exceeds initial expectations.

This week has been dramatic enough; let's get straight to the point. We'll begin with interest rates and exchange rates, move to the FOMC outlook, discuss views on gold, copper, and commodities overall, and conclude with some broader market reflections. I am no expert on this final part—no one fully understands all markets—but having experienced severe downturns, I believe discussing the market from different angles can be helpful. You may also find that conclusions drawn using different methods across sections of this analysis sometimes conflict, which is precisely why I believe waiting for more information by month-end will provide greater clarity for judgment.

Interest Rates: Not Resembling a Hiking Cycle, But a Turn Also Unseen

Thanks to the guidance of former leaders and colleagues, I have established an analytical framework centered on interest rates and exchange rates. As shared before, since my own understanding was limited, consulting many seasoned friends revealed a consensus among experienced traders: look at the charts more.

Let's start with short-term rates.

Since January 2026, short-term rates have risen consistently due to factors like geopolitical conflict and Federal Reserve leadership changes. However, the chart shows the upward slope of short-term rates has been gradually flattening to date, similar to the latter half of 2023 and recent years. This differs from the accelerating rise seen in 2021-2022.

My interpretation is this: when the Fed is determined to conquer inflation, it must be more hawkish than the market expects. This unexpected hawkishness forces the market to repeatedly revise its rate expectations upward, resulting in the steepening slope of short-term rates seen in 2021-2022. This is termed a rate-hiking cycle.

If the Fed is dissatisfied with inflation but sees no need for consecutive hikes, rates will rise but reach a ceiling, producing a chart with a flattening slope, as seen today. This is called policy fine-tuning.

Currently, investment banks, the market, and Fed officials themselves suggest this does not look like a new hiking cycle. I agree. Based on current data, the future does not appear to be one of consecutive hikes. However, I remember the lessons of 2022, so I present two logical arguments supporting the possibility of entering a hiking cycle now.

- From a traditional perspective, the Fed is already significantly behind the desired policy rate.

- Real interest rates in the US have been rising. If AI capital expenditure continues to grow strongly next year, the US economy will remain robust, inflation expectations may not fall, real rates could keep rising, making a hiking cycle entirely plausible.

Rising real rates cannot be attributed to a strong traditional economy. If AI capex maintains a 60% growth rate, I believe real rates will not fall. Inflation expectations are already at a four-year low. If AI investment remains exceptionally strong, the Fed certainly will not cut rates; it might even hike and potentially consider further hikes next year.

The flaws I see in these two arguments are:

- Kevin Warsh's主张 leans towards rate cuts and balance sheet reduction, aligning with the US focus on boosting supply-side capacity. Furthermore, data does not support a wage-price spiral, so there's no need to rigidly apply traditional 2% inflation targets or Taylor's Rule to assess a hiking cycle.

- The market is currently doing the Fed's tightening work spontaneously. If AI investment thrives further under current debt financing conditions, the market itself can push rates higher, potentially allowing the Fed to partially achieve its goals without active intervention. In 2022, with inflation expectations at 3%, a Fed hiking cycle was justified. Now, with expectations around 2.2%, the urgency is less pronounced.

We will revisit policy trade-offs in the FOMC outlook below, but I currently do not believe a full-fledged hiking cycle is imminent. Maintaining the status quo in the short term seems the most likely course.

The current situation resembles this: because Warsh provides no clear forward guidance, the market and his Fed colleagues are out-hawking each other. This narrative will end either with inflation returning to a more reasonable level or with Warsh himself stepping forward to clarify the stance. Both require time—perhaps within a quarter at best, but potentially longer.

Long-Term Rates: A Narrative More Like the 1970s

Long-term rates appear to have more upward momentum than short-term rates, which seems entirely reasonable. The market senses the White House's desire for rate cuts but cannot ignore the US fiscal deficit issue.

I recall when I first entered the industry, studying US PMI revealed a fascinating pattern: before the 1980s, US PMI fluctuations were very rapid. The US economic cycle, like that of emerging markets then, lasted 14-18 quarters. Post-1980, it lengthened to 36-40 quarters.

I was too young to understand why. Explanations included high inflation causing greater economic volatility or Cold War-era fiscal spending. After recent years, I have two additional explanations I hadn't considered before:

- A textbook explanation for interest rates is compensation for default probability. When the world has two major powers, the probability of default is always higher than when one dominates.

- We say emerging markets are volatile because they lack the experience or accumulated capital of developed markets to handle economic shocks. However, large-scale technological revolutions can plunge even developed nations into greater volatility. Faced with rapid technological change and geopolitical conflict, even major powers lack experience, and the required capital is astronomical.

Therefore, I believe even if short-term rates decline in the future, a significant drop in long-term rates is unlikely barring an economic black swan event.

FOMC: Two Choices on the Table

Generally, at FOMC meetings, participants vote among three options: dovish, neutral, or hawkish. As of today, considering the Fed's last meeting and recent statements, a 25bp rate cut is likely not the dovish option for this meeting. Therefore, the dovish option might be:

- Hold rates steady + add language expressing concern about unemployment.

I see this probability as almost zero, as it would mean changing the framework again just a month after the last shift—something Warsh is unwilling to do, and it contradicts statements from any Fed official.

The hawkish option would certainly be:

- Hike rates by 25bp. Current data does not support a 50bp hike option.

The current market-implied probability for this is around 10-15%. However, in my view, the probability might not be that low, not for any complex reason, but simply due to the Strait of Hormuz situation. If tensions there escalate further over the next ten days (which is entirely possible, as Iran seeks control and the US cannot concede it), I believe some voting members might recall Chair Powell's statement in March that oil-price inflation was a temporary disturbance and the Fed would not consider hiking. This could incline them to vote for a hike at this meeting.

Thus, I personally think the market is pricing a 10-15% chance for a 25bp hawkish hike, but if the Strait of Hormuz situation worsens, this probability could rise.

This represents a significant risk worth monitoring, as geopolitics holds many uncertainties, and their combined impact on markets can be multiplicative. This is another reason I believe a cautious, watchful approach is warranted during this period. I have many vivid memories from financial markets: when one negative event can trigger another, or one positive event leads to the next, the probability of two consecutive negative or positive events occurring is often higher than it initially appears.

The neutral option naturally is:

- Hold rates steady while emphasizing focus on inflation or price stability.

This is the market's current base case assumption.