Global financial markets posted strong results in August, but storm clouds may be gathering on the horizon. According to Jeffrey O'Connor, US Head of Market Structure and Sell Side ATS Strategy at Liquidnet, a confluence of factors — rising Treasury volatility, oil's return above $100 a barrel, and stubborn inflation — could create significant headwinds for equities over the coming weeks.
Treasury Market Volatility Takes Centre Stage
O'Connor identifies Treasury market volatility as the biggest story to emerge from the summer. "It creates real headwinds, and it will trickle through to mortgages, to cars, to what builders need to borrow at," he warned. "The rates market is demonstrating that inflation is proving hard to shift."
Oil Climbs Back Above $100
Early expectations that the US-Iran conflict would be short-lived have faded. Oil, which spiked to $110 at the outset of the conflict before easing, has now climbed back above $100 a barrel. With the supply disruption now six months old and no resolution in sight, O'Connor suggests this price level may be where the market should be.
Equity Markets Facing a Reckoning?
Despite the S&P 500 posting gains of around 20% over the past year — driven largely by strong corporate results and a healthy AI sector — O'Connor cautions that sustaining this outperformance will be increasingly difficult. "It will take near perfection or better to keep it going," he said, noting that as AI optimism fades and rates move higher, investors may find better risk-adjusted returns in 10-year or 30-year Treasuries.
Adding to the concern, realised correlations on the S&P are at their lowest since 2024 — a period that was characterised by near-certain rate cuts, in stark contrast to today's environment of near-certain rate hikes. O'Connor sees this as a warning sign. "When correlations get this low, it is usually a sign of elevated risk that will have to reconcile itself."
All Eyes on CPI and the FOMC
Markets are currently in what O'Connor describes as a "volume and volatility vacuum," with the upcoming CPI print and FOMC meeting expected to set the tone. "It will take a week or so for the personality of this market to take shape," he said, adding that the sharp drop in volumes at the end of summer — to the lowest of the year — reflects the current calm before a potential storm.
With oil pushing towards $100 and the 10-year yield at 4.8%, O'Connor believes the next two to three weeks will be pivotal. "At some point," he cautioned, "the equity market is going to have a reckoning."
