Investment markets and key developments

Global shares had another ripper week with major share markets reaching new all-time highs, before retracing slightly on Thursday as the Iran “deal” seems further away than previously thought. US shares rose 3.7% over the week, with broad-based gains across cyclical sectors including consumer discretionary, communications, IT and industrials. The Euro Stoxx gained 2.5%, Japanese shares rose 1.2% and Chinese shares were up 2.2%. Even the ASX 200, which has lagged this year, reached record highs and is now up 3.3%, helped by a positive start to earnings season and gains across most sectors except energy and utilities.

Bond yields ended the week marginally lower, with the US 10-year yield easing to 4.67% from 4.73% last week with markets in a risk-on mood. But the trend remains up since March this year partially driven by inflation concerns. The US Treasury curve has also seen higher term premium lately, reflecting concerns about US economic policy. These include Kevin Warsh’s preference for less forward guidance, reports that Warsh and Trump have maintained regular direct communication (unlike previous Fed Chairs), and Scott Bessent’s help to support the yen intervention (the first in almost 30 years); alongside longer-term worries about fiscal sustainability and structurally higher inflation from trade policy and geopolitical risks.

Even with rising interest rates, equity risk premium (earnings yield above bond yields) remained in the same range they have been in in the last two years. Both actual and forecast earnings are still trending up especially in the US, supported by still resilient economic data, which have propelled shares to new highs despite the unending cycle of news around the US-Iran war.

Markets were on another Middle East war rollercoaster this week, with weekend escalation from the US tempered by Treasury Secretary Scott Bessent’s Tuesday comment that a deal could come “today or tomorrow”. Positive sentiment has helped gold prices break out of a technical resistance level this week to above $4,250/oz (from just around $4,000 last week). But the leaked details of the expected “deal” between Iran and Oman looked unrealistic, with Iran reportedly demanding a ban on US and Israeli ships through the Strait of Hormuz, while the US maintained its regional blockade and pushed for traffic to resume. It is a classic game theory stalemate: neither side wants to back down because escalation serves their own interests! Now four days later, the Houthis have escalated attacks, Saudi Arabia seems to get pulled deeper into the conflict, Hormuz remains closed, and oil prices have bounced back above $80/bbl. It remained rangebound between $80 and $90/bbl in the last week and is unlikely to drop to below $70 anytime soon with all the back and forth – not too different from previous historical conflicts.

That being said, it’s probably best to follow Dr Shane Oliver’s 40-advice to “turn down the noise”; in other words, we can’t be too bearish given that Trump will likely TACO again at some point. In fact in the past week Trump’s approval ratings have fallen again to new lows for this term, with polls showing Americans are much more focused on gasoline prices and inflation than foreign affairs. So for now, it remains business as usual, with shares still supported by solid fundamentals, strong economic growth and rising productivity.

The RBA will likely revise down their inflation forecast next week and hold rates unchanged, but don’t expect this to be the end of the hiking cycle. With headline inflation for the second quarter coming in significantly lower than previously expected (4.0%yoy versus 4.8% forecast by the RBA in May) while the labour market looks weaker (unemployment rate averaging 4.4% vs RBA’s 4.2% forecast), the Reserve Bank certainly has space to hold rates constant for now to further assess the impact of the three rate hikes so far (they impact the economy with a lag!). However, the RBA will retain a hawkish bias, and we see a high chance of one more hike in November especially if the quarterly trimmed mean for 3Q comes out to be 0.8%qoq or higher. Specifically, trimmed mean momentum hasn’t trend down at all in the past two months (and 3.6% annual reading is too far from the 2.5% target), consumer spending is still very solid (see the Australian data section below), wage pressures remained high, and now that the fuel excise is fully reinstated, we think there is more room for businesses to pass through their costs to consumers with “fuel surcharges”! In fact, our pipeline pressure indicator remains elevated around the same levels as early 2023 (when the RBA was in the middle of hiking rates), despite having rolled over from oil price peak in May.

What’s going on with the Japanese yen? The JPY has been sliding since 2021 as Japan continued to experience lower inflation than other developed peers (with core inflation remaining at a meagre 1.2%yoy despite the energy shock this year), lower GDP growth (at just 0.4%yoy for the March quarter), years of low inflation mindset, and as a result, much lower cash rates than other developed economies. Even with the latest rate hike, the BOJ cash rate remained at just 1% with one more 25bps hike priced in by the end of the year. High public debt (at more than 200% of GDP, compared to 128% in the US and ~33% in Australia) is another major factor behind the yen's weakness. More recently, rising commodity prices have worsened the trend, as Japan's overwhelming dependence on imported energy means the country has to pay for energy using more US dollars, reducing demand for yen, thus adding to the downward pressure already coming from low inflation, low interest rates and high government debt.

Donald Trump clearly doesn’t like this, prompting US intervention to support the yen which was summed up by my favourite picture of the week: Treasury Secretary Scott Bessent’s notepad, captured by Reuters, reading “To Do Buy Japanese Yen (JPY) $5–10 bil”. This is because Japan is a major holder of US Treasuries, so large-scale selling of US assets could push up US debt servicing costs (which have already trended up consistently since the Iran War – see the chart below). Trump has also argued that a weaker yen gives Japan an unfair trade advantage, with Japan accounting for 4% of US imports and ranking as its sixth-largest import source.

Even if commodity prices could ease if a sustainable Iran deal is reached and Japan’s wages costs have been picking up lately, the country’s weaker fundamentals and low inflation are long-term issues, so BOJ rates will only rise to around 1.5% by the end of the year. Meanwhile, the Fed is also still likely to raise rates further and we think the yen could stay weak in the next few months. This is also reflected in my own Disneyland index (arguably a much better measure than the Big Mac index), which compares starting prices for a one-day adult ticket at Disney parks: Tokyo still looks very attractive at around A$80 a day, compared with A$95 in Paris, A$105 in Shanghai, A$121 in Hong Kong, A$161 in Los Angeles and an eye-watering A$180 in Orlando.

Major global economic events and implications

73% of the US S&P 500 companies have reported with 78% of them beating expectations, while earnings growth projection remained very solid at 31.8%yoy. Unsurprisingly tech earnings projection is a whopping 49.1% annual growth so far, but energy is the real outperformer at 135%yoy given elevated commodity prices.

Both manufacturing and services ISM surveys for July continued to show strong cyclical momentum in the US economy. Both indices rose over the month to 55.6 and 54.1, respectively, pushed up by new orders, production/business activity, and suppliers’ deliveries; while employment surveys remained softer below 50, the neutral level. Price pressures also eased a bit over the month (though the level remained quite elevated).

Jobs growth as indicated by ADP payrolls was also softer than expected in July (+44k versus +65k expected). But the annual trend seems has been picking up since the beginning of this year…