Macro (Re)View (17/7) | Renewed concerns

An AI-related breakthrough in China renewed concerns over lofty tech sector valuations and proved a stronger headwind for equity markets this week than rising oil prices amid the re-escalation of hostilities in the Gulf. The Nasdaq fell nearly 3% this week, while Asian markets saw much steeper declines of 6-8%, as investors worried that the potential emergence of lower-cost AI models could undermine the returns from the ongoing capex boom in data centres. WTI Brent crude lifted more than 15% to around $82/bbl, its highest levels in a month. Despite this, UST yields declined as pricing for Fed rate hikes moderated after inflation data for June was cooler than expected - but multiple Fed officials, including Chair Warsh said inflation risks have not abated. USD upside, having rallied more than 3% over May and June, remained capped. 

Fed rate-hike expectations for the July meeting have eased from around 40% to a 10% chance after US inflation pressures eased and retail sales were moderate. One Fed hike is expected this year. With gasoline prices falling by almost 10%, headline inflation declined by 0.4% in June, slowing the annual rate from 4.2% to 3.5%. The core rate also softened from 2.8% to 2.6%yr on a flat month-on-month figure. This was subsequently backed up producer prices also falling in June (-0.3%) and rising less than expected after excluding food and energy (0.2%). Retail sales rose 0.2%m/m in June, well down from May's 0.9% gain, though lower gasoline prices were the main driver. However, control group sales - a gauge that remove gasoline and other volatile items - also slowed to 0.5%m/m from 0.8% in May. 

Re-escalating hostilities in the Gulf and renewed pressure on oil prices have come at a time where energy inventories in Europe are causing some concern. While the ECB is expected to hold steady at next week's meeting, this backdrop keeps the chance of further tightening in play. The ECB have strongly pushed back on views that the hike last month was an insurance hike, while the June forecasts also incorporated at least two rate hikes. In the UK, BoE Governor Bailey said that the fragile situation in the Gulf presented risks to the UK outlook. Meanwhile, Gilts responded favourably to reports that PM in waiting Burnham may appoint a more fiscally conservative Chancellor.

Macro (Re)View (10/7) | Hostilities renew

Hostilities in the Gulf flared up again this week with President Trump declaring the ceasefire was over. But with talks continuing, markets have been unbothered for now by a sharp reduction in shipping flows through the Strait of Hormuz. Brent crude oil touched midweek highs above $80 before closing around $75 on Friday, up more than 4% over the week. With the situation fragile, inflation risks persist. That was reflected in further increases in US Treasury yields, driven also by the FOMC meeting minutes noting 'almost all' participants saw rate hikes as necessary unless inflation pressures ease. The RBNZ reached that point this week, hiking by 25bps and indicated rates may rise further. 

Last week's soft US employment report (nonfarm payrolls +57k, unemployment rate 4.2%) left little lasting damage to Fed rates pricing for a rate hike by year-end, in part due to this week's hostilities in the Gulf pushing up oil prices. The minutes from the FOMC's meeting last month reaffirmed that the Fed under new Chair Warsh will at least sound less tolerant to above-target inflation. 

In Europe, the account of the ECB's June meeting where it increased rates by 25bps cast the move as a necessary step, pushing back against the notion of it being an insurance hike. That was backed up by President Lagarde's latest comments, saying that there were signs of second-round effects from the oil price shock flowing through the economy. Over in the UK, the BoE published its semiannual Financial Stability Report, highlighting the resilience of markets to the Gulf conflict; however, AI-related risks and vulnerabilities in parts of the market, including private credit, had increased. Responding to recent speculation, Governor Bailey said there would be no change to current bank leverage rules around government bond holdings. 

On the domestic front, a speech from the RBA's lead economist Sarah Hunter outlined the policy trade-offs facing the central bank. Hiking into the current supply-related shock is a communications challenge as much as anything, given that risks to growth and the labour market appear to be weighted to the downside. Hunter said these considerations need to be weighed up but appeared to argue that because underlying inflation was already elevated it had less scope to be patient.

Australia trade balance back in deficit in May

Australia recorded its largest trade deficit since December 2015 in May, its second deficit of the past 3 months. The trade deficit was $3bn in May, swinging from a $1.4bn surplus in April, with both exports (-6.9%) and imports (2.6%) contributing to the deterioration. The effects of the Gulf conflict, the data centre build out and volatility in gold exports are all playing a role. Nonetheless, the Australian dollar on a trade weighted basis is up more than 4% year to date.  

The trade account was in deficit by $3bn in May as import spending ($46.6bn) exceeded export earnings ($43.6bn). Australia ran trade surpluses every month from the start of 2018 through to February this year. But this result for May was the second deficit of the past 3 months, though the shift has lacked a defining driver. 

The $1.7bn deficit in March came as imports surged (12.9%) to facilitate the data centre build out and due to the fuel price shock from the Gulf conflict. However, the deficit for May was driven by a slump in exports (-6.9%). Even incorporating the rebound to a surplus in April ($1.4bn), the 3-month average for the trade balance was in deficit (-$1.1bn) for the first time since October 2016. 

Exports largely reversed their April rebound (7.2%) with a 6.9% fall in May, coming to $43.6bn - still up by 4.6% over the year. Non-monetary gold was a key factor, with those exports falling by 35% from the prior month. Meanwhile, non-rural goods declined (2.9%) on the back of weakness in iron ore (-9%). 

Spending on imports was up 2.6% to $46.6bn all told in May. That elevates imports to new record highs, having risen by almost 17% over the year. Capital goods rose sharply in the month (8.2%) but are off their recent peak in March when data centre investment went to new levels. A near 8% rise came through in consumption goods, boosted by a surge in new vehicle purchases (24.6%).    

Intermediate goods have gone on a tear following the surge in oil prices stemming from the blockade in the Strait of Hormuz, rising 9.5% in March and 13.8% in April. But that slowed in May to a largely level movement (0.3%). Fuel imports in May were $8.6bn, more than double their pre-conflict level in February ($4bn).