Investment markets and key developments

Global share markets mostly rose over the last week helped by good earnings results and some moderation in expectations for Fed rate hikes. US and Eurozone shares rose to new record highs and Japanese shares also rose. The Korean share market has broken its down trend after long positions were washed out into a 39% fall, with a similar story in semi conductor stocks. Chinese shares fell slightly though.  Despite the positive global lead Australian shares fell around 1.7%, which was partly a correction after a 5.6% rise in the prior two weeks left them overbought but earnings reports are off to a mixed start with worries about slowing housing finance commitments weighing on the banks and sharp falls in industrial, property and material shares also weighing on the market. And of course, the Australian share market doesn’t have much exposure to the AI related stocks that are back in favour again.

Bond yields ended the week marginally lower, with the US 10-year yield easing to 4.64% 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 Trump’s renewed attempt to fire Fed Governor Lisa Cook, 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.

Oil prices had another bounce as there is still no deal to re-open Hormuz (to get up back to where we were before the War started), let alone regarding Iran’s nuclear ambitions (which was the key point of the War in the first place).

While there is still no resolution to the Iran/Hormuz impass, our base case remains that oil prices will stay in a $US70-100 range with Iran preventing it going lower and the US moving to try and calm things down whenever it gets above $US100. While shipping through Hormuz remains depressed, reports from US sources suggest that it is helping more shipping get through (with transponders turned off), but this is unclear. The risk remains that there will be no sustainable peace deal, the flow of oil out of the Middle East remains down 10-15% on normal levels and that we will have to face higher oil prices as reserves run down. This risk may escalate if Trump determines he has got nothing to lose by going a lot harder on Iran, maybe after the midterm elections.

The next chart highlights the slump in the supply of oil since the War began. The global economy has been able to weather this by running down reserves which had built up ahead of the War with a large spike in supply and by some cutback in demand. Note though that some the fall in demand shown in the chart reflects countries like China cutting their purchases of oil as they dipped into reserves so may exaggerate the true fall in oil use. There was a bounce in supply with the brief reopening of Hormuz but there is a limit to how long the world can dip into reserves.

On the geopolitical front another issue to watch is the whether the escalation in the Russia/Ukraine war, marked by increasing attacks in Russia, leads to an aggressive Russian response like a “provocation” of NATO. Ukraine has been increasingly successful in bringing the war into Russia by attacking its energy industry and more than 20 Wildberries warehouses (which is similar to Amazon) to deprive it of export revenue and bring the war home to ordinary Russians. Ukraine’s aim is to bring Russia to talks but Russia may react by provoking NATO to try and get Europe to put pressure on Ukraine. Russia is unlikely to ultimately succeed but it could still briefly unnerve investment markets.

Benign July US CPI means less pressure on the Fed for a rate hike (for now). The core CPI rose an as expected 0.2%mom seeing the annual rate drop back to 2.5%yoy. Producer price inflation also fell but key components were a little bit stronger. Together this implies that the more important core private final consumption deflator will also rise around 0.2%mom and remain at 3.3%yoy. This is still too high but key Fed officials have nominated 0.2%mom or less as required to stay on hold so along with mixed jobs data and benign wages growth means that the Fed will probably stay on hold at its September meeting with the money market’s probability of a hike then dropping to 32%. However, it’s a close call though as projections for the core PCE are running around 0.24% unrounded so it could easily click up to 0.3%mom which is too high for many Fed officials and in any case there is another round of inflation and jobs data before the next Fed meeting. The money market continues to fully price in a hike by year end.

In Australia, the RBA left rates on hold as widely expected, but it signalled a clear tightening bias. Softer than expected readings for underlying inflation, jobs and house prices enabled it to remain in wait and assess mode. But it doesn’t see inflation back to target until late next year, sees the risks as being on the upside to this with Governor Bullock noting that it will raise rates further “if required”, that its “thinking very hard about when to raise” rates and that it only considered a hold or a hike in rates at the August meeting, not a cut. Of course, this could just be jawboning but it’s clear the RBA’s tolerance for more upside disappointment on inflation is low. And rightly so, as the credibility of the inflation target and the RBA is now at risk.

Against this background we expect another RBA hike by year end, possibly in September but probably in November, taking the cash rate to 4.6% as underlying inflation is likely to take too long to fall back to target and the RBA will need to do more to reinforce its credibility. The money market is now seeing a 56% chance of another hike by year end, albeit this is bouncing around with the oil prices.

After spiking to around $2.10 a litre in early August on the back of the removal of the final half of fuel tax relief along with a spike in oil prices petrol prices in Australia have fallen back to around $2 a litre – well above their pre-War levels. They are now around roughly where you would expect them to be given the level of world oil prices.

This leaves the weekly petrol bill for an average Australian household (of $70) at the high end of the range from the last five years, excluding the March high ($90.3). It’s about $8 a week above where it was over the year prior to the War.

The roller coaster ride in US tariff revenue. Last year tariffs were the big story globally as Trump ramped them up into the so-called Liberation Day in particular. This saw custom duty revenue push above $US30bn a month in the second half of last year. But it’s gone negative this year as the Supreme Court ruled many of the tariffs illegal and so the US Government has had to pay out refunds. New “forced labour” tariffs of 10% and 12.5% depending on the country and soon to be announced “excess capacity” tariffs – both under a different laws – will see tariff revenues bounce back but probably only to around $US20-25bn a month.

16th August marks the 49th anniversary of Elvis leaving the building (or so I was told) so here’s my new favourite Elvis song Spinout again. And from a decade later a new take on his last hit while he was alive, Moody Blue.

Major global economic events and implications

US economic data was mostly consistent with solid growth. Small business conditions rose and jobless claims remain low, but existing home sales remain weak.

The US earnings reporting season has now seen more than 90% of S&P 500 companies report with around 87% exceeding expectations. The consensus expectation for earnings growth has now risen to 33%yoy. After adjusting for one off asset revaluations at Alphabet and Amazon its now blown out to 50%yoy. Earnings growth is being led by energy and tech companies. Capital spending by the top five hyperscalers has now been revised up by around 50% and while it initially caused some concerns, those concerns appear to have faded for now.

Eurozone and Japanese earnings growth is also up strongly.

Chinese inflation fell more than expected in July with CPI inflation of just 0.5%yoy and core inflation to just 0.9%yoy. With the Chinese economy continuing to run a huge saving rate with significant excess capacity, inflation is unlikely to be a problem and the old saying that “whatever China exports it deflates” remains valid. EV’s are an obvious example. China continues to require more policy measures to encourage its consumers to consume.