The escalation of the Middle East conflict rattled markets, sending equities to large losses on the week while yields lifted sharply across sovereign bond curves reflecting the expected inflationary effects of an energy price shock. In the FX market, the more cyclical currencies (EUR and AUD) came under pressure amid a USD that benefitted from safe-haven flows.
Cracks have emerged in the US labour market just as inflationary pressures had looked like holding the Fed back from easing. A weak February report saw nonfarm payrolls decline by 92k (vs +55k exp), lifting the unemployment rate from 4.3% to 4.3%. Markets reacted by increasing pricing for Fed easing this year to 45bps (nearly two cuts), up from 35bps ahead of the report. Although poor weather and industrial action played a role in February - participation dropped by a large 0.5ppt to 62% on these effects - payrolls have now fallen in 5 of the past 12 months.
The energy price shock stemming from the Middle East conflict saw a dramatic shift in ECB rates pricing this week, with the outlook for flat to lower rates swinging to a hike by year-end. This also reflected higher-than-expected inflation in February, with both the headline (1.7% to 1.9%) and core rates (2.2% to 2.4%yr) rising. The account of the ECB's February meeting - held pre the conflict - reflected its long-held view of rates being 'in a good place'.
Turning to Australia, markets are pricing the next RBA hike by May and a further 25bps increase before year-end after hawkish comments from Governor Bullock this week, as the December quarter National Accounts confirmed the cyclical upturn in the Australian economy in 2025. Speaking at the AFR Business Summit, Governor Bullock reaffirmed that the inflation outlook forced the Board's hand to hike last month, and that all upcoming meetings should be considered live.
The RBA's view that above-target partly reflects excess demand was then broadly confirmed in this week's National Accounts release. Real GDP growth was 0.8% in the December quarter - in line with RBA and market forecasts - and 2.6% through the clear, a clear acceleration from its pace (1.2%) at the end of 2024. The cyclical upturn in 2025 was broadly based across household consumption and private investment, while public demand showed renewed strength over the back half of the year. Please see my In review feature article here for comprehensive analysis on the National Accounts.
In other key news domestically, household spending rebounded by 0.3% in January, a slightly disappointing result (0.4% expected) on the eve of the RBA's February rate hike (see here). RBA tightening will also be a headwind for dwelling construction in 2026, with approvals already weakening in January by 7.5% (see here). Meanwhile, the trade surplus remained narrow ($2.6bn) in January (see here), while the current account deficit was pressing 3% of GDP in the December quarter, a 7½-year high (see here).
