• Geopolitical jitters. US/Iran tensions dampen sentiment. Equities lower, oil firmer. Cyclical currencies like AUD & NZD weaken. AUD at ~2-month low.
• Data pulse. US CPI confirmed an oil-driven acceleration in headline inflation. ECB expected to hike rates tonight. US producer prices also released.
Global Trends
Risk sentiment has remained on the backfoot with renewed hostilities in the Middle East dampening the market mood. Following President Trump’s proclamation the US would ‘strike Iran hard’ the US launched strikes on multiple targets. The latest moves highlight President Trump’s growing impatience with the stalled ‘peace efforts’/negotiations. Recall, the initial ‘two-week ceasefire’ began in early-April, and reports estimate that since late-March President Trump has declared a deal is “imminent” ~38 times on either social media or in interviews. In response to latest events oil prices edged higher (brent crude +1.8% to US$93.10/brl), while US equities fell again with the tech-focused NASQAD underperforming (-2% vs -1.6% for the S&P500). Bond yields nudged up with US rates rising ~3-4bps across the curve, and in FX while the USD index tread water with EUR hovering near the bottom of its two-month range (now ~$1.1535) cyclical growth linked currencies such as the NZD (now ~$0.5793) and AUD (now ~$0.6996) weakened. The AUD is at levels last traded in mid-April, ~3.8% from its early-May peak.
Macro wise, the May reading of US CPI was also released overnight. Headline and core inflation largely matched consensus predictions. Headline inflation accelerated to 4.2%pa (its fastest pace since April 2023), however core inflation, which excludes the impact from oil prices, ticked up slightly to a more muted 2.9%pa pace. At first glance, outside energy-sensitive categories, US inflation appears somewhat contained. However, as our chart shows, business surveys suggest there are pipeline pressures and that inflation risks over the months ahead remain. Hence, central bankers won’t be able to relax for a while yet. Markets agree with a US Fed rate hike still fully priced in by year-end and ~44bps of tightening discounted by June 2027. This was also the message in Canada. The BoC kept rates on hold at 2.25%, as anticipated, and although policymakers noted limited evidence so far of broader pass-through from energy costs, Governor Macklem stated they would remain ‘nimble’ given the uncertainty.
The European Central Bank meets tonight (10:15pm AEST) and US producer prices are due (10:30pm AEST). The ECB is widely expected to hike rates by 25bps, its first move this tightening phase. As such, focus will be on the messaging about the speed and scale of future moves. There is a risk markets are underwhelmed by a ‘data-driven’ approach from the ECB, which in turn might weigh on the EUR and generate support for the USD. On net, we think the macro undercurrents, upward shift in US interest rate expectations, and shaky risk sentiment could see the USD extend its upswing.
Trans-Tasman Zone
The negative risk appetite stemming from developments in the Middle East has kept the NZD and AUD under downward pressure (see above). At ~$0.5793 the NZD is around the lower end of the range occupied since mid-April and below its 1-year average. The AUD (now ~$0.6996) is also at the bottom of its ~2-month range and ~3.8% from its early-May highs. Underperformance on the cross-rates has also kept the AUD on the backfoot with falls of ~0.3-0.4% recorded against EUR, JPY, GBP, CAD, and CNH the past 24hrs. AUD/EUR (now ~0.6065), AUD/JPY (now ~112.30), and AUD/GBP (now ~0.5234) are around respective multi-week lows, while AUD/CNH (now ~4.7436) has dipped under its 1-year average.
As discussed above, the situation in the Middle East and renewed hostilities between US/Iran could continue to dampen sentiment over the period ahead. As our chart shows, AUD’s sensitivity to cyclical assets like US and global equities has lessened compared to a few years ago, but it is still positive. Hence, further falls in equities could exert more downward pressure on the AUD (and NZD) over the near-term. On top of that, as outlined previously, signs Australian economic momentum is cooling is raising doubts the RBA may raise interest rates further this cycle. Markets somewhat agree with only ~20bps of tightening now priced in by next February (i.e. a ~80% chance of another RBA hike).
Given the RBA appears closer to the end than the beginning of its tightening phase, and views about other central banks like the US Fed are shifting towards hikes, we feel yield differentials may have peaked and could be starting to turn against the AUD. Indeed, other central banks could be about to start to raise rates like the ECB tonight (10:15pm AEST). This, coupled with the slowdown in Australian growth and challenges faced by the global/Asian economy from the Middle East conflict and prolonged disruptions to energy/supply-chains, suggest there are still more downside risks facing the AUD.
