• Market wobbles. Faster US inflation dampened the mood. US equities dipped, bond yields rose. USD firmer. AUD drifted back but still at elevated levels.
• AU Budget. A lot of the big ticket items already known. More spending restraint would have been helpful. RBA still has more work to do in its inflation fight.
Global Trends
A few renewed wobbles across markets overnight. There have been no fresh developments related to the US/Iran conflict with hopes of a long-lasting peace deal fading and the Strait of Hormuz still effectively shut. Added to that, the economic aftermath of what has taken place continues to bubble to the surface. US CPI picked up in April with headline and core inflation both a bit higher than predicted. US headline inflation accelerated to 3.8%pa, its fastest pace since mid-2023, with a jump in gasoline and higher food prices coming through. There was also a noticeable quickening in core services inflation. More direct and indirect pass-through from the surge in oil prices and cascading impact across supply-chains is set to manifest over coming months. According to Chicago Fed President Goolsbee (a non-voter in 2026) if services inflation indicates the US economy is overheating then policymakers have “got to be thinking about how to break the chain”, implying more restrictive settings (i.e. interest rate hikes) are a non-negligible risk down the track.
Markets are now pricing in a ~25% chance of a US Fed rate rise by year-end. The upward adjustment pushed up US bond yields with rates rising ~4-5bps across the curve. In the UK, gilts continue to underperform with the 10yr yield up ~10bps (now ~5.1%) while the 30yr hit ~5.81%, a level not traded since 1998, because of UK political risk. UK PM Starmer is facing mounting pressure to resign with prediction markets giving an ~80% chance he won’t be PM by year-end. US equities lost ground, though the S&P500 staged a late-session comeback to end the day ~0.2% lower after having been down as much as ~1%. In FX, the USD index is a little firmer with EUR slipping back (now ~$1.1740), GBP underperforming (now ~$1.3539), and USD/JPY nudging up (now ~157.61). The NZD (now ~$0.5951) and AUD (now ~$0.7240) also eased with the Australian Federal Budget generating a lot of media noise but not much initial market reaction.
Looking ahead, in addition to any new Middle East news, attention will also be on the upcoming meetings between President Trump and China’s President Xi where trade relations could be a focal point. Data wise, US producer prices (10:30pm AEST) and retail sales (Thurs night AEST) are also due. We continue to think that, in the short run, more signs of quickening price pressures and/or resilient US consumer spending may raise the odds the US Fed contemplates rate hikes later this year. A upward adjustment in US interest rate expectations could give the USD a boost.
Trans-Tasman Zone
The modest gyration in equity markets, upward repricing in US interest rate expectations, and firmer USD on the back of the acceleration in US inflation has taken a little heat out of the NZD and AUD (see above). That said, at ~$0.5951 the NZD is still north of its ~6-month average, while the AUD (now ~$0.7240) is not that far from the top of its multi-year range. The AUD has also held up on a few of the major cross-rates with gains of ~0.1-0.4% posted against the EUR (now ~0.6168), JPY (now ~114.11), and GBP (now ~0.5348). By contrast, there was a modest dip in AUD/CNH over the past 24hrs (now ~4.9169).
In Australia focus was on the latest Federal Government budget last night. A lot of the big ticket items were leaked, so in line with past announcements, the immediate reaction in the AUD was muted. As was reported in the press ahead of the budget one of the most significant adjustments to Australia’s tax system since the GST in 2001 was unveiled with the government announcing changes to negative gearing and capital gains tax. Time will tell if the moves shift the demand/supply needle across the housing market and improve affordability. But in the short-term, there could be downward pressure on house prices, which in turn may dampen household consumption via ‘wealth effects’, compounding the headwinds generated by higher mortgage rates and petrol prices.
In terms of the overall fiscal pulse the FY26 deficit is projected to be ~1% of GDP, a little narrower than prior forecasts. A few savings measures were announced, however there were also new spending initiatives. With fiscal policy “neutral to mildly expansionary” the budget won’t make inflation trends worse but nor will they be helpful for the RBA. Greater spending restraint over the next 12 months would have helped reduce aggregate demand across the economy and created more breathing space for the RBA. We remain of the view that the RBA will need to continue to tap on the brakes with at least one more rate rise in the pipeline. However, for the AUD, that is already baked in with the interest rate curve factoring in another ~42bps of RBA tightening by year-end. We think it will be difficult for the RBA to be more ‘hawkish’ than what is factored in. On top of that we don’t feel the looming growth slowdown has been accounted for, neither have the challenges faced by the global/Asian economy from the prolonged Middle East conflict. With positioning (as measured by CFTC futures) ‘net long’, a lot of positives discounted (the AUD is tracking ~3% above our ‘fair value’ estimate), and given its elevated starting point, we see more downside that upside potential for the AUD over the period ahead.
