• Market forces. Renewed Middle East tensions push up oil. Equities dip. USD a bit softer after the US Fed holds policy steady. AUD underperforms.
• AU CPI. Q2 inflation better than feared. Market pricing for another RBA rate hike pared back. Shift in relative yield spreads an AUD headwind.
Global Trends
After a few positive days risk assets came under some pressure overnight. Renewed tensions in the Middle East somewhat dampened the mood. Skirmishes across the region raised concerns about energy flows and the outlook for talks with President Trump stating that, in response to attacks, “we’ll be hitting them hard”. After falling earlier in the week oil prices jumped up with Brent crude back over US$90/brl. Equities weakened with the S&P500 (-1.5%) and tech-focused NASDAQ (-1.7%) losing ground, while at the same time, oil related inflation worries and central bank rhetoric pushed up long end bond yields with the US 10yr climbing ~7bps to 4.68% (near the top of the range occupied since early-2025).
In FX, the USD dipped this morning. This boosted the EUR (now ~$1.1466) and GBP (now ~$1.3368), while USD/JPY eased a bit, although at ~163.40 it remains at elevated levels. Elsewhere, the NZD perked up a fraction to be just below its 1-year average (now ~$0.5796) and the AUD (now ~$0.6953) clawed back a little of the ground lost yesterday following the softer than predicted Australian Q2 inflation report. That said, the AUD has underperformed on the major cross-rates over the past 24hrs.
A catalyst for the (modest) pull-back in the USD was the US Fed meeting. The US Fed held interest rates steady. This was the expected outcome for most analysts, however markets had been factoring in a ~33% chance a rate hike could be delivered at this meeting, so the mechanical downward adjustment in front-end interest rates dragged on the USD. That said, we would note the Fed decision wasn’t unanimous with 3 members of the committee voting for a hike. Aside from the vote split, the accompanying statement was largely unchanged with officials repeating their pledge to “deliver price stability”. There is a lot of uncertainty regarding what the US Fed may do given the push-pull forces at work across the US/global economy, as well as the diverging views among policymakers. The lack of any concrete forward guidance from new Fed Chair Warsh is another thing markets, which had become accustomed to hand holding by policymakers, are learning to live with.
On net we believe the positive momentum in the US economy, stickiness in inflation, and signs the jobs market is improving should keep alive the prospect of the US Fed potentially adjusting its policy stance down the track. US Q2 GDP and the PCE deflator (the Fed’s preferred inflation gauge) are due tonight (10:30pm AEST). Ultimately, the Fed might not crystalize market pricing, but in the short-term the thought that it could lift rates should, in our view, keep US yields elevated and this can be a source of support for the USD. Markets are pricing in a ~60% chance the US Fed hikes rates at the next meeting in September with 2 rate rises discounted by next June.
Trans-Tasman Zone
While the slightly softer USD in the wake of the ‘no change’ US Fed outcome has helped perk up the NZD, at ~$0.5796 it is only back where it was tracking earlier this week and broadly in line with its 1-year average. Similarly, the AUD (now ~$0.6953) has ticked up, however this only partially unwound yesterday’s Australian CPI inspired dip with the AUD underperforming on the cross-rates. The AUD depreciated by ~0.4-0.7% against CNH, NZD, and JPY the past 24hrs, with larger moves coming against GBP (-0.9%) and EUR (-1%).
Australian headline inflation slowed in June (now ~3.8%pa), and although the quarterly trimmed mean ticked up to 3.6%pa this was below consensus forecasts (i.e. 3.7%pa) and what the RBA penciled in (i.e. 3.8%pa). A better than feared outcome in Q2, but inflation is still too high and not where it needs to be. The question is whether the RBA is patient/more forward looking and places more weight on the unfolding slowdown across the economy that could dampen inflation down the line, or if it will take out more ‘inflation insurance’ and push through another hike this cycle at the cost of even slower growth/higher unemployment over the next ~12-18 months.
Markets have shifted towards the latter with odds of an August RBA rate hike pared back (now just ~4%), and only ~17bps of further tightening factored in by next March. We agree with market thinking, and as outlined previously, we believe the RBA is closer to the end of its cycle (if not already there) than the beginning, given the slowdown in the Australian economy. Concerns about the growth outlook, coupled with the swing in relative yield spreads, and wobbles in risk assets point to more headwinds for the AUD over the next few weeks, in our view. The AUD may also be facing seasonal pressures given it has tended to underperform in August. Since the mid-80’s AUD/USD has declined in August ~60% of the time. It is even higher for cross-rates like AUD/EUR (~70%), AUD/JPY (~62%), and AUD/CNH (~64%).
