Since the beginning of March global markets have been volatile as the war with Iran commenced and the Strait of Hormuz has effectively closed. Consequently, oil prices have risen by about 40%, despite comments from President Trump earlier in the week that the war would soon be over. This in turn pushed bond yields up sharply on expectations for higher inflation and kept share markets under downwards pressure. Australian and global equity markets are down about 6% from their highs and are expected to remain under pressure as it’s clear that the war has a way to go yet. With Iran remaining defiant, attacking more energy infrastructure and ships in the Persian Gulf and Strait of Hormuz and warning of oil going to $US200 a barrel. So, Trump has no easy off ramp.

 

 

In the US the Fed (Wednesday) is expected to leave rates on hold at 3.5-3.75% after cutting rates three times last year as growth remains solid and core private final consumption inflation is still around 3% YoY. The dot plot of Fed officials’ interest rate expectations is expected to continue to allow for one cut this year and one next year. Powell is likely to express comfort with the current level of interest rates and indicate that it can afford to wait to see what happens to inflation.

 

We now think the RBA will hike rates today. Since the last meeting stronger than expected growth and jobs data appear to have reinforced RBA concerns about capacity constraints and the RBA appears very concerned the boost to inflation from the war’s impact on oil prices (which at current petrol prices will add 1% to inflation taking it to around 5%) will add to inflation expectations – which were already on the rise again - making it even harder to get inflation back down. This has been reinforced by hawkish comments since the war started by both the Governor and Deputy Governor suggesting that they are inclined to act quickly to be more confident of getting inflation back down. 

 

This is a potential double whammy for households. For mortgage holders another 0.25% rate hike would mean roughly an extra $110 a month in mortgage interest payments. If petrol prices stay at current levels, it will cost the average household around an extra $78 a month versus their February average. So nearly a $190 a month extra for those with an average mortgage and a car that’s not electric, quite a hit!

 

Global and Australian share markets are at high risk of further falls in the near term in response to the War with Iran against the backdrop of stretched valuations, political uncertainty associated with Trump & the midterm elections and AI bubble & tech valuation worries. We continue to see a 15% or so top to bottom fall in share markets along the way this year. However, returns should still be positive for the year thanks to Fed rate cuts, Trump’s consumer friendly pivot ahead of the midterms and solid profit growth. 

 

Bonds are likely to provide returns around running yield.

 

Unlisted commercial property returns are likely to be solid, helped by strong demand for industrial property associated with data centres. 

 

Cash and bank deposits are expected to provide returns around 4%.

 

The $A is likely to rise as the interest rate differential in favour of Australia widens as the Fed cuts and the RBA holds or hikes. Fair value for the $A is around $US0.72.