Oil & bond yields still in the driver’s seat

Peter Dragicevich, Currency Strategist, APAC

• Market wobbles. Higher oil prices & rising yields dampen sentiment. Equities dip, USD firmer. AUD & NZD lose ground. AUD underperforms on crosses.
• Data pulse. ECB raised rates overnight. US CPI due tonight. Markets pricing in a ~70% chance US Fed hikes next week. US CPI could generate volatility.

Global Trends

It was a case of rinse and repeat across markets overnight with another jump in oil and move higher in bond yields darkening the mood. In terms of oil a greater ‘supply risk premium’ continues to be incorporated with the renewed Middle East hostilities and heightened chances of an even more drawn out conflict on people’s minds. A senior Iranian official said they would not back down in response to the US naval blockade and could escalate strikes. On the other side The Wall Street Journal reported that President Trump’s advisers have warned the war may run through to 2029, while the President has stated the conflict might not end before the November midterms. Brent crude oil futures have risen above US$107.50/brl, a high since May, while Dated Brent (which is the physical spot-market price that better reflects immediate demand/supply) has surged to ~US$120/brl.

The inflation impulse stemming from the increase in oil is a factor pushing up bond yields with traders factoring in multiple rate hikes by central banks. The European Central Bank raised rates another 25bps overnight and kept the door open to do more given inflation worries, while in the US producer prices quickened as fuel and commodity prices boosted transportation and goods costs. Concurrently, there are also underlying concerns about high debt burdens and the mismatch between demand/supply in government bonds. Due to persistently large budget deficits US government debt is approaching ~US$40 trillion. Yesterday’s announcement by President Trump that every adult US citizen could receive a US$5000 cheque if the Republicans win the November midterms would add another ~US$1.35 trillion to government expenditure. The backdrop has propelled the US 10yr yield up ~12bps to ~4.96% (highest since 2023), with the 30yr yield (now ~5.37%) at levels last traded in mid-2007. Long-end rates in the UK, Japan, Germany, and Australia are also at multi-year peaks. The ‘higher for longer’ interest rate environment weighed on equities with the S&P500 and NASDAQ shedding ~0.6%. In FX, the USD strengthened with USD/JPY edging up (now ~154.46), while EUR (now ~$1.1608) and GBP (now ~$1.3510) lost a bit of ground. NZD remains on the backfoot (now ~$0.5797), and the AUD underperformed after a solid run (now ~$0.7157).

Tonight, the macro focus will be on US CPI inflation (10:30pm AEST). We see a risk the data is firmer than consensus forecasts. In our view, if realised, this could further bolster the case for a US Fed rate hike as soon as next week, and generate more support for the USD which may also be underpinned by elevated oil prices (given the US’ status as a ‘net energy exporter’) and shaky risk environment. Markets are assigning a ~70% chance the US Fed lifts interest rates on 16 September, with ~2 hikes discounted by January and ~3.5 moves factored in by Q3 2027.

Trans-Tasman Zone

Wobbles in risk markets, as illustrated by the dip in equities and pullback in base/precious metal prices (copper -4.8%, silver -5.7%), stemming from another jump in oil and higher bond yields exerted downward pressure on the AUD and NZD overnight (see above). At ~$0.5797 the NZD is back below its 1-year average with the latest decline adding to the weakness that has come through since the RBNZ’s recent ‘dovish’ rate hike. The AUD (now ~$0.7157) has slipped to where it started the month, with the AUD also weakening by ~0.2-0.7% against EUR, JPY, GBP, and CNH over the past 24hrs.

Tonight, attention will be on the US CPI data (10:30pm AEST). As discussed above, we believe the data may show sticky inflation pressures, which if realised, could reinforce the outlook for US Fed rate hikes being delivered over coming months with a move as soon as next week a possibility. This, combined with the more challenging risk environment and elevated oil prices (which are supportive for the USD given the US’ morphed into a ‘net energy exporter’ a few years ago) might keep the AUD under pressure, in our view.

More broadly, as mentioned previously, while short-term momentum seeking AUD traders have been drawn to the idea of another RBA hike, we don’t think it should be the catalyst for even more AUD strength. As outlined before, while a higher RBA cash rate/wider rate spreads translate to a higher average level for the AUD compared to the last few years it doesn’t mean there should be much more upside given: (a) the elevated starting point; (b) what is factored into the interest rate curve (a late-September RBA hike is assigned a ~82% chance with ~2.5 rate rises now discounted by mid-2027); (c) the hit to the local growth from rising mortgage costs; (d) the outlook for other central banks to deliver more than the RBA from here; and (e) the AUD is near ‘overbought’ levels on technical indicators.